When choosing an investment, it can be a real challenge to decide which financial product offers you the best deal. It is particularly confusing when you deal with investments where interest is compounded several times a year. In these cases you receive interest on your interest and the total interest on your initial investment is higher than your nominal interest rate. A useful tool to help you know the overall interest you will receive is the annual percentage yield, or APY, of an investment, which accounts for the effects of compound interest on an account.
Ask your investment provider what your annual interest rate is. Ask how many times a year the interest rate will be applied to your account.
Write down the formula for annual percentage yield: APY=((1+r/n)^n)-1. In this formula, "r" stands for interest; and "n" stands for the amount of times your interest is compounded in a year. For example, if you receive interest on the balance of your investment every month, your "n" number would be 12. The symbol "^" means you have to multiply the previous term by itself "n" amount of times. For example, the term 2^4 is the same as writing 2 x 2 x 2 x 2.
Insert the information of your investment into the formula and solve the resulting equation. For instance, if your interest rate is 5 percent and your account is compounded monthly, your equation would look like this: APY =((1+5/12)^12)-1 and the solution would be 5.12 percent.
Items you will need
- Comstock Images/Comstock/Getty Images
- Credit Card Interest Rate Vs. Simple Interest Rate
- How Do I Determine the Interest Paid on a Certificate of Deposit From the Bank?
- How to Calculate Nominal Yield
- How to Calculate Accrued Interest on a Quarterly Compounding CD
- The Difference Between Holding Period Yield and Annual Period Yield
- A Daily Compound vs. a Semi-annual Compound Savings Account