Definition
APY is the actual annual rate of return on a savings account or investment, accounting for the effect of compounding within the year. Unlike a simple annual interest rate, APY reflects how frequently interest is added to your balance — so a 7% rate compounded monthly has a higher APY than the same rate compounded annually.
Example
A savings account advertises 5% interest compounded monthly. The APY is 5.12%, because interest earned in January itself earns interest in February, and so on through the year. On a $10,000 deposit, the difference between 5% simple and 5.12% APY is $12 after one year — small now, but significant over decades.
How It’s Calculated
APY = (1 + r/n)n − 1, where r = annual interest rate (decimal) and n = number of compounding periods per year. For 5% compounded monthly: APY = (1 + 0.05/12)12 − 1 = 0.05116, or 5.12%.
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