Saturday, June 09, 2012

How to calculate Annual Percentage Yield – APY

Bank savings accounts grow your money. When you have money in a bank savings account, your money earns interest. This is a nice feature. Your bank savings account pays a rate of return on all the money in the account (your Annual Percentage Yield). That means that you get "paid" for keeping your money in the account. If you were not going to use the money anyway, then getting paid a little is better than nothing.

Calculating Annual Percentage Yield (APY) is not as difficult as you think.  Justin Pritchard in his Guide explains that Annual percentage yield (APY) is a tool for evaluating how much a deposit earns you. Why would you look at an account’s APY? This is because it is a standardized way of comparing investments. Your job as a consumer is to put your money where it will get the highest APY.
What is APY?
As the name suggests, APY is the yield you earn on a deposit over a year. It refers to your earnings – how much money you’re making. Because we all want our money to work for us and grow, it is important to get a good APY from the bank.
What is Unique About APY?
APY is notable because it takes compounding into account. In very simple terms, compounding denotes that you are making earnings on your earnings. This means that the quoted APY is telling you how much you’re really making on your money. Other ways of quoting a rate do not necessarily show you the whole picture.
·         See a Visual Example of Compound Interest

How to Get the Best APY
In general, you’ll find that the APY is higher for more frequent compounding periods. Ask your financial institution how often they compound. If your money is compounded daily as opposed to quarterly, you will be able to earn a better APY.
You can also pump up your own “personal APY”. Justin Pritchard always urges people to look at all of their assets as one. In other words, don’t think of one Certicificate of Deposit(CD) investment as separate from your checking/current account – they all go together and should be considered one. Think of yourself as the Chief Financial Officer of You, Inc.
To pump up your personal APY, find ways to make sure that your money is compounding as frequently as possible. For instance, If 2 CDs pay the same interest rate, pick the one that pays out interest most often (monthly instead of at maturity, for example). Then, you can reinvest your interest payments and start earning interest on that payment.

How to Calculate APY With Ease
Calculating an investment’s APY can be tricky. If you want to just find out what an APY is with Excel, here's the function:
=POWER((1+(A1/B1)),B1)-1 where A1 is the Rate and B1 is compounding frequency.
Try pasting this formula into any cell on a spreadsheet (except A1 or B1). In cell A1 you’ll put the stated annual interest rate – in decimal format. For example, if the stated annual rate is 6%, you’ll type “.06” in cell A1. Then, you put the number of times you’ll compound each year. For example, for daily compounding you would enter “365” (or 360 depending on the institution) in cell B1.
In the example used, you will find that the APY is 6.183%. In other words, if you get 6% annually with daily compounding, your APY = 6.183. Try changing the compounding frequency and you’ll get an idea of how the APY changes. For example, you might show quarterly compounding (4 times per year) or the unfortunate 1 payment per year (which just results in a 6% APY).
The APY Formula
If you like doing math the old fashioned way, here is how to calculate APY:
APY = (1 + r/n )n – 1 where r is the stated annual interest rate and n is the number of times you’ll compound per year.
Finance people will recognize this as the Effective Annual Rate (EAR) calculation.
Now that you are up to speed on APY and how it works, go out and find the best APY you can get!

No comments: