How to Calculate APY on an Investment

According to financial experts, you earn a yield on your investments, and you pay a rate on your loans. Annual percentage yield for investments is a useful calculation to compare the investment performance of two different investments, to see which is performing better using all available factors. The calculation can be done manually by using an algebraic formula, or by using a financial calculator. Understanding how the APY is computed is useful to understanding overall investment performance.

Definition

APY is the rate of return that an investment provides when compared to your initial investment. In simple terms, if you invest $10,000 and after one year have earned $1,000 on that investment, your return is 10 percent. The APY is determined by considering other factors as well, such as how many compounding periods exist each year for the investment.

Calculate the Total Gain

With a bank account, gain is the balance of your account less your deposits. With other investments, knowing the total gain is more complicated. With a stock market or equity investment, you will have gains from the increase in value in the stock, as well as the dividends that you may earn due to the stock's profitability. The market value of the stock on the last day of the year less the price at the beginning of the year determines the gain in value. Add that figure to your total dividends for the year to calculate your total gain.

Determine the Compounding Periods

Some banks pay interest on certificates of deposit or bank accounts daily, but interest is also paid monthly or quarterly. With daily compounding, the number of compounding periods is usually 365, but it could be 360 depending on the method your bank uses for calculation. With equities or bonds, dividends or interest are paid at different time periods, depending on the issuer. Dividends are often quarterly, paid four times per year. Bond interest may be paid monthly, quarterly or yearly, as well as at the maturity date of the bond, which could be several years in the future.

Perform the Calculation

First divide the investment by the total gain to determine the percentage of gain. With the example, it was 10 percent. If the interest is paid monthly, divide the total return by 12 to obtain the monthly return, or 0.00833 in the example. Add 1 to this for a total of 1.00833. Raise that number by an exponent equal to the amount of compounding periods. With monthly compounding, you would raise that number to the 12th power, giving an answer of 1.10466. Subtract 1 from that number, giving an annual percentage yield of 10.466 percent.