Maximizing Annual Percentage Yield

Annual percentage yield (APY) is the rate charged for borrowing or earning money over the course of a year. It's a handy metric to have in mind, especially if you can distinguish it from simple interest and understand how to calculate it. Once you grasp APY, you can determine how to maximize your money held in a bank.

When you deposit funds into a savings account, money market, or certificate of deposit (CD), you earn interest. APY can help you understand how much interest you'd earn on the account over a year, considering the interest rate and compounding frequency. It shows you the interest you would earn on the principal plus earnings.

Compared to a simple interest rate, APY gives a more accurate indication of how much you will earn on a deposit account because it factors in compounding. Compounding occurs when you earn interest on both the original principal and on your returns.

annual payment Example

Suppose you deposit $1,000 in a savings account with a 5% simple annual interest rate. If the bank calculates and pays interest only once a year, they would add $50 to your account. At the end of the year, you would have $1,050. In contrast, with monthly compounding, you would have more than the quoted 5% interest rate at $1,051.16 by the end of the year.

In the table below, note how earnings increase slightly each month with monthly compounding.

APR vs. APY

Annual percentage rate (APR) is the simple interest rate that a bank charges over a year on loans and credit cards, similar to APY but without factoring in compounding. Credit card loans illustrate the importance of distinguishing between APR and APY, especially considering the higher APY you often pay with a balance.

Calculating APY With a Spreadsheet

You can find APY quoted from banks, but you can also calculate it on your own. Spreadsheet software like Excel or Google Sheets can help with the computation. For example, paste the formula =POWER((1+(5%/12)),12)-1 into a cell to calculate an APY of 5.116% with a 5% annual rate compounded monthly.

Figuring APY With a Formula

If you prefer manual calculations, compute APY using APY = 100 [(1 + r/n)^n] – 1 where r is the annual interest rate as a decimal and n is the compounding periods per year. For example, the APY for an account earning $51.16 interest on a $1,000 balance over a year would be 5.116%.

Maximizing APY

APY increases with more frequent compounding periods, so check how often interest compounds in your accounts. To maximize your personal APY, view all your assets as part of a larger financial picture and aim for more frequent compounding. Reinvest interest earnings regularly to earn more on those payments.