What APY is and why it's higher than the nominal rate
When a bank or investment platform advertises a nominal rate of, say, 5% a year compounded monthly, that doesn't mean you get a single 5% payout at the end of the year. In practice, you earn roughly 0.417% each month (5% divided by 12), and each of those small monthly earnings starts earning interest too in the following months. That compounding effect makes the real return over the year a bit higher than the advertised 5% nominal rate — and that real return is exactly what APY represents.
Formulas used
APY from the nominal rate: APY (%) = ((1 + nominal rate ÷ 100 ÷ n)^n − 1) × 100
Final value using APY: FV = P × (1 + APY ÷ 100)^(months ÷ 12)
Where n is how many times the rate compounds per year (365 for daily, 12 for monthly, and so on), and P is the deposit amount.
Practical example
A 5% nominal annual rate compounded monthly works out to an APY of roughly 5.12% — a 0.12 percentage point difference purely from the monthly compounding effect. On a $10,000 deposit over 12 months, that difference amounts to about $12 more in earnings just from how the interest compounds, even with the nominal rate staying the same.
Why compounding frequency matters when comparing accounts
It's entirely possible for an account with a lower nominal rate to pay out more over the year than one with a higher nominal rate, if the first one compounds more frequently. An account at 5.0% a year compounded daily can produce a higher APY than one at 5.2% a year compounded only once a year, depending on the gap between the nominal rates. That's why comparing only the number a bank advertises can lead to the wrong choice — the correct comparison is always between APYs, never between nominal rates.
APY and ROI aren't the same thing
APY is an annualized, projected rate calculated from a financial product's nominal rate and compounding frequency. ROI (return on investment) is an observed result after the fact, measuring what a specific investment actually earned. You can use APY to estimate the expected ROI of a fixed-rate investment, but for variable-return investments, the stated APY rarely matches the final result exactly.
What this calculator doesn't account for
This simulation doesn't include taxes on earnings, account or management fees some products charge, or the possibility of the nominal rate changing over time on variable-rate products. Treat the results as a comparison estimate between products, and always confirm the full terms before investing.