The term annual percentage yield (APY) is the total amount of interest earned on an account for a period of one year, expressed in percentage.
It takes into account the effect of compounding interest, which is useful for comparing the actual rate of return of an account since comparing simple interest rate won’t give you the actual rate of return. Annual percentage yield does not take into account any fees associated with the account that might affect the net yield.
How to Calculate APY
To illustrate how the annual percentage yield is different from getting the simple interest earned in a year, let us assume that there are two investment accounts. One has a flat interest rate of 12% per annum. Another has an interest rate of 1% per month for 12 months.
It might seem that the total earnings for both accounts will be the same at 12% per annum. However, if you get the annual percentage yield for the second account, it will be more than 12%, since the interest rate of 1% per month compounds.
With the example above, if you compare the annual percentage yield, it would seem that the second account will give you a better total yield. However, the fees associated with the accounts were not taken into consideration. If the fees for the first account are significantly less compared to the second account, you can still have the same total yield for the two accounts, or even a higher yield for the first account.