APY

See: Annual Percentage Yield

Annual Percentage Yield

The yield on an investment in one year, taking into account the effects of compounding. For example, if one has a fixed-income investment such as certificate of deposit that pays 3% in interest each month, the annual percentage yield is more than 3% because compounding the interest results in a (slightly) higher return each month. In this example, the annual effective yield is calculated thus:

Annual percentage yield = (1.03)^12 - 1 = .43 = 43%, where 1.03 is 1 plus the monthly interest and 12 is the number of times in a year interest is compounded. It is also known as the annual effective yield.

Annual percentage yield (APY).

Annual percentage yield is the amount you earn on an interest-bearing investment in a year, expressed as a percentage. For example, if you earn $60 on a $1,000 certificate of deposit (CD) between January 1 and December 31, your APY is 6%.

When the APY is the same as the interest rate that is being paid on an investment, you are earning simple interest. But when the APY is higher than the interest rate, the interest is being compounded, which means you are earning interest on your accumulating interest.