Annual Percentage Yield

Written by Amanda Dixon

Edited by Marie White, CEPF®

Updated on May 15, 2025, 3:26pm ET

When you save or invest your money, you expect to earn some sort of return. With deposit accounts like certificates of deposit or savings accounts, banks need a way to measure the return that you can expect. Enter the annual percentage yield (APY). An APY is a percentage that tells you how much you’ll earn on an investment, including compound interest, in one year. It’s a critical piece in determining your total earnings over time.

Consider working with a financial advisor as you evaluate various securities and savings options.

How to Calculate the Annual Percentage Yield

The annual percentage yield formula is (1 + (i / n))ⁿ – 1.

In this equation, i is equal to the annual interest rate, and n is equal to the number of times that interest compounds each year. If your interest rate is listed as a periodic rate (a 1% monthly rate, for example), you can substitute that for (i/n).

To see how the annual percentage yield plays out in real life, let’s say you’re considering opening a savings account. The annual interest rate is 2.5%, compounded monthly.

Plugging those numbers into the formula, you’d get (1+(0.025/12))^12 – 1. That would result in an APY of 2.529%.

How Compound Interest Works

When you invest your money, your goal is to earn as much interest as possible. Many refer to compound interest as earning interest on top of interest. That’s because it’s the amount of interest you receive from your initial investment, combined with the interest earned on that interest, over a period of time.

Simple interest, on the other hand, is just the interest you receive from the money you actually invested. Compound interest is better for investors because it allows them to earn more money in a shorter amount of time. How quickly your earnings grow depends on how often the interest compounds, whether that’s daily, monthly, quarterly, semi-annually or annually. More frequent compounding means your money grows faster.

To illustrate why compound interest is preferred, let’s take a look at an example. Perhaps you’re torn between putting $2,000 into a savings account with a 1% simple interest rate and an account with a 1% interest rate that compounds annually. After one year, you’ll have the same amount of interest – $20.

After two years, however, you would earn $40 from the first account (with simple interest) and $40.20 from the account that compounds annually. That extra 20 cents is your interest added onto your original amount of interest.

It doesn’t help much in the short term, but in the long run, compound interest can significantly boost your savings.

Higher APYs Are Better for Investors

A woman reviewing the annual percentage yield on her account.

A higher APY generally indicates that interest is compounding more frequently. For savers, having a savings vehicle that compounds monthly is better than one that compounds just once a year.

That’s not the case, of course, if you’re looking at the APY for a loan. If you’re trying to pay off student loans, for instance, you want a low APY and interest that compounds as infrequently as possible.

Generally speaking, the APY will be higher for riskier or less liquid investments. As an investor or saver, that means you’ll make more interest if you lock up your money (say, in a multi-year CD) or take a risk (by investing in a lower-grade bond). As a borrower, the APY you pay on the loan will be higher if you yourself are a greater risk. An example would be someone with a low credit score.

APY vs. APR

The annual percentage yield and the annual percentage rate (APR) are easy to mix up, but they are two completely different things. The APR is the total amount of interest that accrues within a whole year for either taking out a loan or investing your money.

A regular interest rate only tells you the cost of taking on debt at one point in time. That length of time could be a day or a month. You’ll typically hear about the APR in reference to debt-related accounts like credit cards and mortgage loans.

The biggest difference between APR and APY is compound interest. Unlike APY, the annual percentage rate does not consider compound interest. That’s why the APR will be lower if you see both the APY and APR together. Plus, the APR generally includes fees, which APY doesn’t account for.

When Should You Prioritize APY in Your Finances?

When you’re saving money for medium- or long-term goals, it makes sense to prioritize APY because it tells you how much your money can grow over time with interest. Choosing a savings account, certificate of deposit or money market account with a higher APY can help your savings keep pace with inflation and earn more without extra effort. This is especially helpful if you plan to leave your money untouched for months or years.

If you need regular access to your money or plan to withdraw often, APY might matter less than other features like low fees or easy transfers. For example, a free checking account with no maintenance fees and convenient ATM access could be more useful than one with a small APY. In short-term savings situations, the interest you earn may not be significant enough to outweigh flexibility and account access.

APY is also more important when comparing similar accounts or products. If two savings accounts have the same fees and minimums but different APYs, the one with the higher APY can help you earn more interest over time. But if an account offers a higher APY while charging higher fees or locking your money away longer, it’s a good idea to weigh those trade-offs before deciding.

Bottom Line

A group of employees attending a conference.

All savings vehicles have an annual percentage yield that shows investors how much they can earn within a year. Because the APY takes compound interest into account, it can be beneficial to people who are looking for opportunities to make the most of their investments. If you’re investing but cannot choose between the two types of accounts, it’s best to take the one with the higher APY, all things (including fees) being equal.

Tips on Borrowing and Investing

Whether you’re thinking of making a big investment or taking out a big loan, it’s smart to consult with a financial advisor first. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
The APY on a savings account at your local bank will be pretty low. But you can find much higher savings rates at online banks, with some offering interest rates north of 4%.