Annual Percentage Yield is important because it gives you a better understanding of the way that keeping money in savings has greater benefits over a longer period of time. Because your investment compounds on itself, you are actually earning more on your money than the basic interest of a single year. (On the other hand, if you are paying interest and let your debt pile up, the APY works in the opposite direction to hurt you.)

So how do you calculate APY? First, begin with basic interest. If you put $100 in the bank for one year at 5% interest, then you will have $105 at the end of the year. That is interest on your deposit or investment. This calculation is the same whether you are calculating APY on a daily basis, weekly, monthly, or whatever.

Annual Percentage Yield comes into effect if you leave that $105 in the bank for another year at another 5% interest. Now, you are getting interest of 5%, but it is worth more because you are starting on a base of $105. After this second year, you will have $110.25 in the bank. And so you have $10.25 of interest for 2 years – or 5.125% of Annual Percentage Yield. This is more than if you got your 5% on $100 each year – because that would be only $110.

If you leave the money in for a third year, then you would have $110.25 x 5%, which is $115.76. And dividing by 3 years, you have 5.25% Annual Percentage Yield. The APY will continually rise each year by just a tiny bit, until its rise is so small that it’s basically negligible.

The actual formula is explained very well on www.investopedia.com. In words, what you do is to take 1 plus the annual interest rate (in decimals), and multiply by however many years you want to leave the money invested. Then subtract 1 from the number you have calculated for the APY. I can’t show it well in Helium format, so just go to the Website mentioned to see it as an equation.

As you can imagine, if you have a lot of money and let your money sit for a long time, these tiny differences can add up to be significant amounts of money.