If you have an account offering a 5% Annual Percentage Yield (APY) on an initial deposit of $100, your money will grow to $105.00 after one year.
Understanding Annual Percentage Yield (APY)
APY represents the true rate of return earned on an investment over a year, taking into account the effect of compounding interest. Unlike a simple interest rate, which may only apply to the principal balance, APY provides a more accurate picture of your total earnings by including the interest earned on previously accumulated interest.
For instance, if you were to deposit $100 for one year at an interest rate of 5% compounded quarterly, your balance at the end of the year would be $105.09. This scenario demonstrates how an interest rate with compounding can result in an effective annual yield (APY) that is slightly higher than the stated rate, with 5% interest compounded quarterly effectively yielding approximately 5.095%. When an account explicitly states a 5% APY, it signifies that, regardless of how frequently the interest is compounded, the overall effective annual growth of your principal will be precisely 5%.
Calculating 5% APY on $100
To determine the final amount when applying a 5% APY to a $100 principal, you simply multiply the principal by the APY expressed as a decimal and add it back to the principal.
- Identify the Principal: The initial amount is $100.
- Convert APY to Decimal: 5% APY is equivalent to 0.05 in decimal form.
- Calculate Interest Earned: Multiply the principal by the decimal APY:
$100 (Principal) × 0.05 (APY) = $5.00 (Interest Earned) - Determine Total Balance: Add the interest earned to the original principal:
$100 (Principal) + $5.00 (Interest Earned) = $105.00 (Total Balance)
Here's a simple breakdown of the calculation:
| Description | Amount |
|---|---|
| Initial Deposit | $100.00 |
| Annual APY | 5% |
| Interest Earned | $5.00 |
| Total Balance | $105.00 |
Key Takeaways
- Accurate Reflection: APY offers the most precise representation of your annual earnings on an investment, as it fully incorporates the impact of compounding.
- Simplified Comparison: By standardizing returns to an annual percentage, APY makes it straightforward to compare various financial products, even if they have different compounding frequencies.
- Clear Growth Projection: Understanding APY allows you to clearly visualize how your savings or investment will increase over a year, aiding in financial planning.
