12 June 2024 | By INDIE
Annual percentage yield, or APY, is a crucial concept in personal finance. Investors need to understand APY to measure the return on their savings and investments, considering the interest rate and its compounding effect.
This article aims to provide a comprehensive understanding of the concept of APY and how it can benefit investors.
APY full form is Annual Percentage Yield. In India, APY, or annual percentage yield is also referred to as annual percentage rate of return. So, what is APY in banking? Well, APY is the interest earned on your investment or the annual yield that you generate from your savings account, recurring deposits, fixed deposits, etc. The annual percentage yield is typically expressed in the percentage of the initial investment.
One of the most important things to note in the APY concept is that it factors in the effect of compounding. Though the APY represents the interest earned on investments or assets over a year, the frequency of interest payout may not also be yearly for all financial products. Hence, the frequency of compounding is taken into account while calculating the APY.
The following are the key elements of the annual percentage yield
1. It factors in the interest rate considering the frequency of compounding associated with the savings account, deposit account, or investment.
2. Investors can utilize APY as a comparative tool to measure the return efficiency of investments. APY can vary for two investments having the same rate of interest but different compounding frequency.
3. APY represents the earnings more accurately and helps investors compare investments based on their actual earning potential.
4. Along with interest rate and compounding frequency, APY also factors in fees associated with the investment.
APY takes into account of annual rate of interest and compounding frequency per year to calculate effective annual yield on investment. The following is the formula for APY:
APY = [(1+r/n)n – 1]
In this,
r – annual rate of interest
n – compounding frequency per year
For example, if you have a savings account that pays you interest quarterly, the compounding frequency to be plugged in the above formula is 4. The savings bank interest rate is taken as the annual rate of interest while calculating APY.
It is important to note that the daily balance is taken into consideration while calculating the savings account interest. Savings bank interest rates and the compounding frequency may vary from one bank to another. Online calculators are also available to calculate the annual percentage yield.
Also read: Digital savings account: How savings accounts have evolved over the years
The following are some of the common banking products offered by financial institutions and banks on which APY is applicable:
Savings accounts are typically meant to encourage savings and provide individuals with safe safekeeping of their funds. These accounts earn interest based on the daily balance maintained in the account. The frequency of interest payout and the rate of interest may vary from bank to bank, which also significantly affects the APY calculation.
Also read: Maximize your returns with INDIE’s high-interest savings account
Recurring deposits are regular monthly deposit accounts similar to fixed deposits that earn a fixed rate of interest. APY in this represents the annualized return earned from investments into recurring deposits.
Fixed deposits or time deposits are lump sum investments for a specific tenure at a fixed rate of interest. Banks offer various types of fixed deposits for varying tenures and interest rates. The APY on fixed deposits represents the actual return generated from investment for a year.
To sum up, APY is typically associated with the savings products offered by the banks. Understanding the concept of annual percentage yield can help investors to rationally compare the two savings products on their actual potential earnings and make an informed decision.
Disclaimer: The information provided in this article is generic and for informational purposes only. It is not a substitute for specific advice in your circumstances. Hence, you are advised to consult your financial advisor before making any financial decision. IndusInd Bank Limited (IBL) does not influence the views of the author in any way. IBL and the author shall not be responsible for any direct/indirect loss or liability incurred by the reader for making any financial decisions based on the contents and information.
