How do I calculate APY (Annual Percentage Yield)?
Formula of APY
APY = (1 + r/n )n – 1
Where,
r = interest rate.
n = the amount of times per annum that the interest is compounded.
Now take an example and calculate APY.
r = 12%
n = 12 (months)
APY = [1+(0.12/12)]12 -1
APY =[1+(0.01)]12 -1
APY =1.1268-1
APY = 0.1268
APY = 0.1268*100%
APY = 12.68% round 12.7%.
Difference between APR & APY
APY and APR are two ways how to calculate interest on investing money.
A PR is the simple interest takes into the principal amount APY is the rate with the effect of compounding or the interest on interest. It is the interest you earned on previously earned interest.
Let’s take an example to better understand the difference between APR and APY. Suppose you deposit $50,000 in the bank and you earned 1% interest per year so APR will be 1% per year that will be $5,000 but in the first month you will not get $5000 but you got 1%/12 that will be 5000/12=417.
So each month you will get $416 and at the end of the year you will earn $5000 that is APR now if it is APY you will earn $416 in January so your balance amount will be $50,417 in January but in February you will not have only $50000 principal amount but $50,416 because you earned $417 dividend in January now in February you will earn a dividend on $50,416 that might be $50,832 and in same in March and so on so.
APR is a simple interest but APY is earning interest on the principal and previously earn interest which will grow with that time.
Effect of the Compounding frequency
Compounding effect is the most powerful force of the world Einstein says, “it is 8th wonder of the world. A person who understands it earns from it, and who doesn’t pay it”.
To better understand the compounding effect let’s read this story.
A king plays chess first time and he loves to play it he called his creator and appreciate him and ask his wish that what do you wish for. Its creator says nothing else just give me one grain of rice on the first square of chess and then double it on every square of chess. The king and his fellows laugh at him that he can wish for a gold diamond or any expensive thing but how silly he is asking just for some grains of rice. He ordered his soldiers to give him what he wants after some days soldiers come to the king and says, he is not a silly man but he is too sharp, we don’t have so much rice as he wants everyone in the darbar was shocked. Now see how clever he was. Chess has 64 squares put one rice on 1st square and double it.
Total weight= 461 billion metric tons
Nowadays value will be 300 trillion dollars. Which is equal to the wealth of the whole world so he was not a fool but so intelligent and know the power of compounding.
That’s why we say a person who knows the power of compound he will earn from it and who does not know the power of compounding has to pay for it.
Basically compounding effect is also called the Domino effect or snowball effect from compounding interest you earn interest on previously earned interest and its impact grows with time.
What is a good APY rate:
Many online banks offer APY around 1%. The national average is just 0.05 %. Most banks offer below than 1% depends on a product so we can say 1% is a good APY rate
Is APY paid monthly:
APY is the amount of interest you earned on your Bank account in one year. But interest will be paid out according to the agreement with your bank. It can be monthly semi-annually, quarterly, or yearly, depends on the policy of the bank or investor.