The annual percentage yield (APY) is the real rate of return earned on a savings or investments taking into account the effect of compounding interest.
Compounding interest is calculated periodically and the amount is immediately added to the balance which is the major difference from simple interest. The account balance grows with each period going forward, so the interest paid on the balance also gets bigger.
- APY is the actual rate of return that will be earned in one year if the interest is compounded.
- Compound interest is added periodically to the total invested, increasing the balance. That means each interest payment will be larger, based on the higher balance.
- The more often interest is compounded, the better the return will be.
APY Formula and Calculation
APY is calculated by:
(1+periodic rate)^# Periods−1
In this formula, 1 is the deposited amount. In case you deposited $100 for one year at 5% interest and your deposit was compounded quarterly, at the end of the year you'd have $105.09. In case of simple interest, you would have had $105.
Not a big change, right? But in four years you would have $121.99 instead of $120 with simple interest.
How it works in the Wealth App
Inside the app you can find Estimated Yield - it shows how much interest you will earn at the end of the period.
With daily compound interest, it is calculated by this formula:
Interest of the day = (((1+gross_APY)^(1/365)-1) * active_balance ) * (1-fee)
(with APY and fee as numbers between 0 and 1. Example: 8% => 0.08)