One of the best ways to grow your money is to invest it. Rather than just waiting to be used, money that you've invested "works" for you, earning interest when it would otherwise be stagnant. Whether you are putting your money in a high-interest savings account, getting a certificate of deposit (CD) or investing in bonds, you'll be earning interest on the dollars that you invest. In order to understand how much you can expect to earn, it's important to be able to calculate the APR, or annual percentage rate, on your investment.
What Is Annual Percentage Rate?
The annual percentage rate is how much you can expect to earn from your investment over a year. APR is expressed as a percentage, since the amount that you earn will depend on how much you initially invested.
It's important to know what APR does and doesn't include. Usually, APR includes fees and other costs that you can expect to receive, which is why APR is generally a higher percentage than the official interest rate. However, APR doesn't take into account compounding interest, which can make a huge difference in how much you're actually earning.
What Is Annual Percentage Yield?
Annual percentage yield solves this issue by showing you how much you will earn, taking into account compounding interest. Compounding interest means that the borrower is paying the interest rate not only on the principal investment, but also on any earned interest. This adds up quickly, so in order to get a more accurate picture of what you are likely to earn, it's important to account for compounding interest. Also known as effective annual rate, annual percentage yield will show you your expected earnings on an investment that has compounding interest.
How To Calculate APR Percentage
In order to calculate APR or annual percentage yield, you have to know the terms of your investment: how much you invested, any fees you can expect to be paid, what the interest rate is and how often the interest will be compounded. To calculate APR, you add up all of the interest and fees that you will be paid over the course of a year. Then, you divide that total by the amount of your initial investment. That will give you the APR percentage.
For example, if you invest $100,000 at an interest rate of 6 percent, you'll earn $6,000 in interest. Add to that the $3,000 in fees that you can expect from your investment. In total, you'll earn $9,000 this year from the investment. Dividing the earnings ($9,000) by the initial investment ($100,000), you can calculate that your APR in this case would be 9 percent.
Calculating annual percentage yield is a bit more complicated, since you need to account for the accumulating interest. A variety of online calculators allow you to easily determine what your annual percentage yield is given the terms of your investment.
Kelly Burch is a freelance journalist living in New Hampshire. Her writing on educational issues has appeared on Bright, The Washington Post, We Are Teachers and School Leaders Now.