APY

APY (Annual Percentage Yield) is the effective annual return on a savings or investment product, including compounding. Computed as APY = (1 + r/n)ⁿ − 1 where r is the nominal annual rate and n is the number of compounding periods per year.

APY is distinct from APR, which excludes compounding. A 6% APR compounded monthly is roughly 6.17% APY — the difference grows with rate and compounding frequency. Banks quote APY for savings accounts (where they want to overstate returns) and APR for loans (where they want to understate cost). The 17-basis-point gap on a single year may look small; on a long-term investment it’s the difference between a steady accumulator and an underperformer.

Worked example

$10,000 invested at 6% nominal, compounded monthly for one year. Monthly rate = 6% ÷ 12 = 0.5%. After 12 months: 10,000 × (1.005)¹² = 10,616.78. That’s a 6.168% effective return. APY = 6.17%, vs the 6.00% nominal APR. Over 10 years the same starting capital grows to $18,194 (vs $17,908 if compounding only annually) — a $286 difference from compounding frequency alone.

What “APY” doesn’t include

APY isolates the time-value-of-money effect; it doesn’t account for taxes, fees, inflation, or risk. A 5% APY on a CD is a known nominal number — but in a 7% inflation year you’re losing 2% of real purchasing power. Bank account fees (monthly maintenance, minimum-balance penalties) can also wipe out modest APYs; check the schedule before assuming the headline number is what you get.

Where you’ll see APY

• High-yield savings accounts (current US online-bank rates: 4-5% APY)
• Certificates of deposit (CDs) — fixed APY for a fixed term
• Money-market accounts
• Cash management accounts at brokerages

For loans (mortgages, auto, credit cards) the equivalent metric is APR, which sometimes also bundles upfront fees. Knowing both lets you compare offers symmetrically. Compute the future value of any APY scenario in our compound interest calculator.

Continuous-compounding limit

As compounding frequency n grows, APY approaches e^r − 1. At 6% nominal: monthly compounding gives 6.168%, daily gives 6.183%, continuous gives 6.184%. The marginal gain past daily is negligible — which is why “compounded continuously” in marketing copy is almost always equivalent to “compounded daily” in practice. The structural lever is the rate, not the frequency: a 50-basis-point rate bump dwarfs any compounding-frequency optimisation.

When the distinction matters

For one-month decisions (where to park cash before a closing), APY vs APR rounding is noise. For multi-year decisions — emergency funds, 529 plans, retirement cash sleeves — the difference compounds. A retiree comparing a 4.50% APR CD against a 4.55% APY money-market account is comparing apples to oranges: the CD’s effective yield depends on compounding terms in the fine print. Always normalise to APY before ranking offers. The Truth in Savings Act (Regulation DD) requires US depository institutions to disclose APY using a standardised formula, which is why the number on a bank’s rate sheet is directly comparable across institutions even when nominal rates and compounding periods differ.