What is APY?
Annual Percentage Yield (APY) is a measure of the return on investment (ROI) earned on a savings account, certificate of deposit (CD), or other financial product. It is calculated by taking into account the interest rate, any additional fees, and the frequency of compounding. APY is a more accurate measure of the ROI than the interest rate alone, as it factors in the effects of compounding.
Example
For example, let's say you have a savings account with an interest rate of 2%. If you make no withdrawals or deposits, you will earn $2 on a $100 balance after one year. However, if your bank compounds interest daily, you will earn slightly more than $2. This is because interest is earned on interest, which creates a snowball effect.
How is APY calculated?
APY is calculated using the following formula:
APY = (1 + r/n)^nt - 1
where:
r = interest rate
n = number of compounding periods per year
t = number of years
For example, let's say you have a savings account with an interest rate of 2%, which compounds interest daily. The APY would be calculated as follows:
APY = (1 + 0.02/365)^365 - 1 = 2.007%
How to use APY to compare financial products
When you are comparing different financial products, it is important to look at the APY. This will give you a better idea of the true ROI you can expect to earn. For example, let's say you are considering two different savings accounts. One account has an interest rate of 2%, while the other account has an APY of 2.05%. The second account has a higher APY, even though the interest rate is the same. This is because the second account compounds interest daily, while the first account only compounds interest monthly.
How to increase your APY
There are a few things you can do to increase your APY:
Choose a financial product with a high APY.
Make sure your financial product compounds interest frequently.
Avoid making early withdrawals.
Consider opening a high-yield savings account or certificate of deposit.
By following these tips, you can increase your APY and earn more on your savings.
Conclusion
APY is an important factor to consider when you are saving money. By understanding APY and choosing financial products with high APYs, you can earn more on your savings.
