# How to Calculate Annual Percentage Yield (APY)

By Timothy Moore · July 15, 2024 · 7 minute read

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Annual percentage rate, or APY, is the rate of interest earned on a savings or investment account in one year, including compound interest (the interest you earn on interest). Unlike the nominal interest rate, which does not consider the impact of interest compounding, APY provides a more accurate picture of how much you’ll earn in an account over the course of one year. This allows you to compare different financial products and make informed decisions about where to put your money for the best returns.

Read on to learn the basic APY meaning, how to calculate annual percentage yield, and some of the limitations of APY.

## Understanding Annual Percentage Yield (APY)

An abbreviation for annual percentage yield, APY indicates how much interest a bank account, such as a high-yield savings account or certificate of deposit (CD), earns in one year, expressed as a percentage.

An APY includes the effect of compounding interest, which is when you earn interest on both the money you’ve saved (principal) and the interest you earn. Depending on the bank and type of account, interest on an account can compound (i.e., get calculated and added) yearly, monthly, quarterly, or daily. The more frequently an account compounds, generally, the more the account will earn.

That’s why it’s important to consider APY — and not just the interest rate — when looking for a bank account. Comparing APYs helps you compare financial products as apples to apples by letting you know the real return on the account. Almost all savings accounts, and some checking accounts, have an APY.

### Simple Interest vs Compound Interest

Understanding APY involves knowing the difference between simple and compound interest. With simple interest, an account holder earns interest only on the principal, or the initial amount of money they deposited. With compound interest, on the other hand, an account holder earns interest on the principal along with the accrued interest.

Compound interest helps your money grow faster, as you’ll earn interest on your interest. The frequency of compounding is important; the more often your interest compounds, the more money you’ll generally earn. An account may compound interest daily, monthly, quarterly or annually.

When it comes to savings and investment accounts, simple interest is less common than compound interest.

Recommended: Difference Between APY vs Interest Rate

## Calculating APY

There is a specific formula for calculating APY. To use it, you’ll need to know your interest rate and how frequently the interest compounds.

APY = (1 + r/n)^n – 1

Where:

•   ^ = to the power of

•   r = the nominal interest rate

•   n = the number of compounding periods per year

### APY Calculation Examples

To see how much compounding frequency can affect your APY, let’s look at four examples with the same interest rate but four different compounding periods (annually, quarterly, monthly, and daily).

•   Annual compounding interest: n = 1

•   Quarterly compounding interest: n = 4

•   Monthly compounding interest: n = 12

•   Daily compounding interest: n = 365

Assume a nominal interest rate (r) of 5.00%.

Annual compounding interest:

APY = (1 + .05/1)^1 – 1

APY = 5.00%

Quarterly compounding interest:

APY = (1 + .05/4)^4 – 1

APY = 5.09%

Monthly compounding interest:

APY = (1 + .05/12)^12 – 1

APY = 5.12%

Daily compounding interest:

APY = (1 + .05/365)^365 – 1

APY = 5.13%

As you can see, the more often interest is compounded, the higher the APY is. Choosing an account or investment that compounds daily will yield a higher amount earned from interest at the end of the year.

Fortunately, you don’t have to do any fancy calculations to learn the APY of a bank account. To help people compare accounts and accurately estimate possible earnings, banks are required to display account APYs.

Recommended: Use this APY calculator to start comparing APY.

### Fixed vs Variable APY

Another factor to consider with APY is whether it is fixed or variable. Savings accounts, checking accounts, and money market accounts are typically variable rate accounts. This means the APY can change over time depending on market conditions.

Fixed rate accounts, on the other hand, have an APY that does not change during the term of the account. For example, a certificate of deposit (CD) account usually has a fixed APY for the term of the CD. No matter what happens to market rates, the APY will stay the same.

Both types of APYs have pros and cons. Locking in a fixed APY can be beneficial if market rates go down after you open the account. However, it could be a negative should market rates go up, since you won’t benefit from the increase.

Recommended: What Is a High-Yield Checking Account?

## Limitations and Considerations of APY

Knowing the APY for an account or investment can tell you a lot, but there are other factors to consider when choosing where to put your money. Here are a few other things to keep in mind.

•   Fees and penalties: Some financial products come with monthly and incidental fees or penalties that can impact the effective return. APY calculations typically do not account for these additional costs, so it’s a good idea to consider them when evaluating the overall profitability of a deposit account or investment.

•   Liquidity: While CDs often have higher, fixed APYs compared to traditional savings accounts, your money is tied up until the maturity date. That means you can’t access that money in the event of an emergency if you want to earn the interest you were promised upon investing.

•   Fixed vs. variable: A high-yield savings account may advertise a high APY right now, but it is likely variable. This means that as the market changes, the interest rate could go down. It’s a good idea to routinely check how much interest your savings account (or checking account or money market account) is earning. If the APY has significantly dropped, you may want to consider opening a bank account with a higher APY elsewhere.

•   Inflation: Inflation erodes the purchasing power of money over time. While APY provides a return rate, it does not account for inflation. To understand the real rate of return on any type of account or investment, it’s important to adjust an APY for inflation.

•   Taxes: Interest earned on savings accounts is typically subject to taxes. The APY does not consider the impact of taxes on the effective return. So it’s important to factor in tax obligations when evaluating the net return on an investment.

## The Takeaway

Understanding and calculating APY is essential for making informed financial decisions. Whether you’re evaluating savings accounts or investment products, APY provides a clear picture of the true return, accounting for the effects of compounding interest. By comparing APYs, you can see how different savings vehicles stack up against each other. This can help you choose the most profitable options and optimize your financial growth.

Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.

Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy up to 4.60% APY on SoFi Checking and Savings.

## FAQ

### What is the difference between APY and APR?

APY stands for annual percentage yield and tells you how much interest you’ll earn on a deposit or investment account over the course of one year, including compounding interest (which is when your interest also earns interest). APR stands for annual percentage rate and represents the annual cost of borrowing money. It includes the interest rate plus any fees and costs associated with the loan or line of credit to reflect the real cost of borrowing.

### How do you calculate the APY for a savings account or investment?

To calculate the annual percentage yield (APY) for a savings account or investment, you can use this formula:

APY = (1 + r/n)^n – 1

Where:

•   ^ = to the power of

•   r = the nominal interest rate

•   n = the number of compounding periods per year

Banks and credit unions are required to display the APY of their financial products, so you generally don’t need to do any calculations. If you know the APY and how much you’ll be depositing, you can use an online APY calculator to determine how much interest you’ll earn by the end of the year.

### What factors can affect the APY of a financial product?

The main factors that affect the annual percentage yield (APY) of a financial product are the nominal interest rate and how often the interest compounds (meaning gets calculated and added to the account). Generally, the higher the interest rate and the more often it compounds, the higher the APY.

SoFi members with direct deposit activity can earn 4.60% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate.

As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.60% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than \$5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or \$5,000 in Qualifying Deposits to your account, you will begin earning 4.60% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or \$5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or \$5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or \$5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.