APY
BankingDefinition
Annual Percentage Yield is the true annual return on a deposit or investment after accounting for compound interest. It's always higher than the stated nominal rate because it includes the effect of interest earning interest.
When a bank advertises a savings account at "5% APY," that's the real return you'll earn over a year. This makes APY the most honest number for comparing savings accounts, CDs, and other interest-bearing products. Federal regulations require banks to quote APY on deposit accounts, which is why you see it everywhere.
The difference between a nominal rate and APY grows larger with more frequent compounding. Daily compounding produces a slightly higher APY than monthly compounding at the same nominal rate.
When a bank advertises a savings account at "5% APY," that's the real return you'll earn over a year. This makes APY the most honest number for comparing savings accounts, CDs, and other interest-bearing products. Federal regulations require banks to quote APY on deposit accounts, which is why you see it everywhere.
The difference between a nominal rate and APY grows larger with more frequent compounding. Daily compounding produces a slightly higher APY than monthly compounding at the same nominal rate.
Formula
APY = (1 + r/n)^n − 1
r = nominal rate, n = compounding periods per year
r = nominal rate, n = compounding periods per year
Example
A high-yield savings account offers 5.0% nominal rate compounded daily:
APY = (1 + 0.05/365)^365 − 1 = 5.127%
On $100,000: you'd earn $5,127 instead of $5,000 - an extra $127 from compounding alone. Over 10 years with reinvestment, that compounding advantage grows exponentially.
APY = (1 + 0.05/365)^365 − 1 = 5.127%
On $100,000: you'd earn $5,127 instead of $5,000 - an extra $127 from compounding alone. Over 10 years with reinvestment, that compounding advantage grows exponentially.