Understanding Annual Percentage Yield (APY)
How Your Money Grows
Whether you're stashing cash in a savings account or comparing investment options, understanding how your money earns interest is key to making smart financial decisions.
One of the most important terms you'll encounter is the Annual Percentage Yield (APY) — a metric that reflects the real rate of return on your savings, factoring in the power of compounding.
In this article, we'll break down what APY is, how it's calculated, how it differs from APR, and how to use APY calculators to better understand your potential earnings. This should give you a much better idea of how savings grow over time.
What Is APY?
Annual Percentage Yield (APY) is a standardized way of expressing the total amount of interest you can earn on a deposit account in one year, assuming the interest is compounded. It's how much money you make by keeping money in some kind of savings account. It's designed to help consumers compare different interest-bearing accounts—like savings accounts, money market accounts, and certificates of deposit (CDs)—on an apples-to-apples basis. The higher the APY, the more money you make.
The key distinction between APY and a basic interest rate is that APY accounts forcompound interest. This means that it includes the interest you earn not just on your initial deposit, but also on the interest that accumulates over time. Depending on how often interest is compounded (daily, monthly, quarterly, etc.), the total amount you earn can be significantly higher than what the base interest rate alone would suggest.
For example, if you deposit $1,000 into a savings account offering a 5% interest rate compounded monthly, your actual return after a year will be slightly more than $50. That’s because each month, the interest earned gets added to your balance, and the next month’s interest is calculated on that larger amount. APY reflects this effect in a single, easy-to-understand number.
In essence, APY provides a more accurate measure of your potential earnings and is especially useful when comparing accounts with different compounding frequencies or promotional rates. It helps you answer the question: “How much interest will I actually earn in a year?”
Example: APY Growth Over 12 Months
Let's say you deposit $1,000 into a savings account offering a 5.00% APY with monthly compounding. Here's how your balance grows month by month:
| Month | Balance Earning Interest | Interest Earned | Ending Balance |
|---|---|---|---|
| 1 | $1,000.00 | $4.17 | $1,004.17 |
| 2 | $1,004.17 | $4.18 | $1,008.35 |
| 3 | $1,008.35 | $4.20 | $1,012.55 |
| 4 | $1,012.55 | $4.22 | $1,016.77 |
| 5 | $1,016.77 | $4.24 | $1,021.01 |
| 6 | $1,021.01 | $4.25 | $1,025.26 |
| 7 | $1,025.26 | $4.27 | $1,029.53 |
| 8 | $1,029.53 | $4.29 | $1,033.82 |
| 9 | $1,033.82 | $4.31 | $1,038.13 |
| 10 | $1,038.13 | $4.33 | $1,042.46 |
| 11 | $1,042.46 | $4.34 | $1,046.80 |
| 12 | $1,046.80 | $4.36 | $1,051.16 |
After one year, your initial $1,000 grows to $1,051.16 — a return that reflects the power of monthly compounding included in the 5.00% APY. This is because every month, the amount that is earning interest goes up.
How Is APY Calculated?
The formula to calculate Annual Percentage Yield (APY) is:
APY = (1 + r / n)n – 1Where:
r = Annual interest rate (as a decimal)
n = Number of compounding periods per year
This formula shows how compounding increases your effective return. The more frequently interest is compounded (e.g. monthly, daily), the more you earn.
If you prefer not to calculate this manually, an APY calculator can do the work for you. These tools allow you to plug in key variables and instantly see your expected earnings.
How to Use an APY Calculator
To estimate how much your savings will grow, enter the following fields:
- Starting Amount: Your initial deposit or balance.
- APY: The annual percentage yield offered by the account.
- APR: If APY is unknown you can use an APR and compounding frequency to derive APY.
- Compound Frequency: How often interest is compounded (e.g., daily, monthly, quarterly).
- Duration: The time your money stays invested or saved (usually in months or years).
- Monthly Deposits: Additional recurring contributions made each month (optional).
The calculator then estimates your total interest earned and your ending balance, helping you plan for both short- and long-term savings goals.