From Justin Pritchard,
Your Guide to Banking / Loans.
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Annual percentage yield (APY) is a tool for evaluating how much a deposit earns you. Why would you look at an account’s APY? Because it is a standardized way of comparing investments. Your job as a consumer is to put your money where it will get the highest APY.

What is APY?

As the name suggests, APY is the yield you earn on a deposit over a year. It refers to your earnings – how much money you’re making. Because we all want our money to work for us and grow, it is important to get a good APY from the bank.

What is Unique About APY?

APY is notable because it takes compounding into account. In very simple terms, compounding means making earnings on your earnings. This means that the quoted APY is telling you how much you’re really making on your money. Other ways of quoting a rate don’t necessarily show you the whole picture.

• See a Visual Example of Compound Interest

How to Get the Best APY

In general, you’ll find that the APY is higher for more frequent compounding periods. Ask your financial institution how often they compound. If your money is compounded daily as opposed to quarterly, you’ll be able to earn a better APY.

You can also pump up your own “personal APY”. I always urge people to look at all of their assets as one. In other words, don’t think of one CD investment as separate from your checking account – they all go together and should be considered one. Think of yourself as the Chief Financial Officer of You, Inc.

To pump up your personal APY, find ways to make sure that your money is compounding as frequently as possible. If 2 CD’s pay the same interest rate, pick the one that pays out interest most often (monthly instead of at maturity, for example). Then, you can reinvest your interest payments and start earning interest on that payment.

How to Calculate APY With Ease

Calculating an investment’s APY can be tricky. If you want to just find out what an APY is with Excel, here's the function:

=POWER((1+(A1/B1)),B1)-1 where A1 is the Rate and B1 is compounding frequency.

Try pasting this formula into any cell on a spreadsheet (except A1 or B1). In cell A1 you’ll put the stated annual interest rate – in decimal format. For example, if the stated annual rate is 6%, you’ll type “.06” in cell A1. Then, you put the number of times you’ll compound each year. For example, for daily compounding you’d enter “365” (or 360 depending on the institution) in cell B1.

In the example I’ve used, you’ll find that the APY is 6.183%. In other words, if you get 6% annually with daily compounding, your APY = 6.183. Try changing the compounding frequency and you’ll get an idea of how the APY changes. For example, you might show quarterly compounding (4 times per year) or the unfortunate 1 payment per year (which just results in a 6% APY).

The APY Formula

If you like doing math the old fashioned way, here’s how to calculate APY:

APY = (1 + r/n )ⁿ – 1 where r is the stated annual interest rate and n is the number of times you’ll compound per year.

Finance people will recognize this as the Effective Annual Rate (EAR) calculation.

Wrap-up

Now that you’re up to speed on APY and how it works, go out and find the best APY you can get!

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