What Is APY And Why Does It Matter To You?

Share on facebook
Share on twitter
Share on linkedin

Annual percentage yield or APY is a measurement that tells you just how much money a deposit or investment with a fixed interest rate will make over a year. It can be a great tool for deciding where best to deposit your money. Of course, you could look at interest rates as absolutes, but that won’t give you an accurate picture of performance over a period, for example, a year.

That’s because of compounding. Supposing you invest an amount of money and receive monthly interest. Provided that you don’t withdraw anything, the interest now forms part of the interest-earning total, so you’re literally earning interest on interest.

Calculating Your Annual Percentage Yield

You can calculate your APY using a formula: APY= (1 + r/n )n – 1

In this formula, r is your interest rate per period and n is the number of periods you want to calculate APY for. But calculating your annual percentage yield can be as easy as using an online calculator.

What’s The Use Of APY?

If you’re choosing between options that pay a fixed interest rate periodically, looking at the percentage interest doesn’t give you the full picture because it doesn’t take compounding into account.

By using APY, you can determine exactly how much interest you will earn on your investment and be better able to choose the most profitable option. For example, a deposit that offers you 5% quarterly and compounds will be better than one that offers you 6% annually.

Since you would like to grow your savings, APY can be compared to inflation so that you know whether your money is gaining or losing value over time. If your money buys less because of inflation, an investment can actually become worth less in real terms even if it’s growing in absolute terms. Remember to factor this in when making decisions.

Fixed interest rate investments are reliable in that you know what to expect from them, and the risk is low. But if using them actually makes your overall worth lower, you will know that it’s time to look at alternatives that might be riskier, but will also have the potential to generate inflation-beating returns. You don’t know for sure till you do the math or use the calculator to understand the numbers.

Make The Most Of Your Cash

Even if you’re already an investor who generates greater value through a balanced stock portfolio, you will need to have some easily available cash in interest-bearing accounts. Placing it where it earns the highest APY helps you to get the most value from it.

At times when stocks and shares are volatile, you might decide to leave some of your investment funds in an interest-bearing account while you wait to see which way markets are headed. 2022’s market volatility, for example, calls for investors to be cautious when redeploying resources. And that, in turn, implies finding a good place to leave your cash until you can decide whether investments are likely to gain or lose value.

Investment is a long-term way to grow your money, but carries risk. Interest-bearing accounts are generally slow growers, and inflation can outpace them, but they’re safe options and may actually gain value provided the APY outperforms inflation. Do the calculations to choose the smartest options.