Tutorial : APR vs APY - Understanding The Both Difference

Hello Friend,

I am so excited to have your here at my post today. Indeed I give thanks to God Almighty, for our life and that of our friends. Today I have presented a new tutorial post, which is titled : APY vs APR - Understanding the Both Difference.

I know as a crypto trader or an investor, you may have come across these two terms APY and APR, at the time you were looking into DeFi products (decentralized finance).

APY stands for Annual Percentage Yield, meaning a percentage that incorporates interest that is compounded daily, weekly, monthly or quarterly, while APR stands for Annual Percentage Rate meaning a percentage that doesn't incorporate interest.

The simple distinction which you have just read can make a significant difference to the calculation for returns of investment of a period of time. To this it is very important for you to understand how these two phenomenal are calculated and what it means for the return that you earn on your assets (cryptocurrencies).

APR vs. APY

Source

APR and APY are both Important phenomenal for the purposes of personal finance. Let’s start by looking at, APR (annual percentage rate). Is the interest rate that you earn on your money as a lender that a borrower pays for making use of it for over 1 year time. i.e the interest rate that a lender earns on their money which is pays by a borrower for using it for over a 1 year time.

Example, if you deposit $10,000 into your savings bank account with a 20% APR, you will earn $2,000 as your interest after 1 year. Your interest is calculated by multiplying the principal amount of your money which is ($10,000) and the APR which is (20%). ($10,000 × 20 ÷ 100) = $2,000. This means that after 1 year, you will have a total of $12,000 which Is your interest plus your principal amount.

Now, if you continue with your savings, after 2 years your capital will amount to $14,000. After 3 years it will amount to $16,000, you will have $18,000 for 4 years and as you keep savings that is how you will keep on earning interest.

Now before looking at APY (annual percentage yield), let's first have a deep understanding about what compound interest is about. In a nutshell, compound interest simply means earning interest on the prior interest. From the example we just look at above, if your bank pays an interest into your account monthly, your bank balance will look different during each of the months. Meaning January balance will be smaller, February balance will be greater than that of January vice-versa.

Instead of you getting $12,000 at the end of the 12 month of your savings, you will review some interest every month. The interest which you receive each month will be added to the principal amount of your deposit, the amount on which you earn each month will keep on rising as the months go by. In every month, you will have more earning interest which is called compounding.

Now let's assume that you deposit $10,000 into your savings bank account with a 20% APR, with the interest compounding each month. Without you stress yourself calculating your interest, you will earn $12,429 at the end of 1 year. In this case, $429 is the interest that is earned by adding it to effect of your compound interest.

The power of compounding is more profitable than the extended periods. After 3 years, you would end up to $19,309 using the same 20% APR product with compounding interest daily. By doing this you will see that you have earned $3,309 more interest than using 20% APR products.

Designed with Excel

By incorporating compound interest, in your savings, you’d earn a lot more on your money (savings). Also you should note that the interest differs according to the compounding frequency. You will get to earn more when the compounding is more frequent. Daily compounding will give you interest that is more than that of monthly compounding.

How to calculate how much you earn when your bank or financial product offers you with a compound interest

In this case, you have to apply your knowledge in APY (annual percentage yield). In order to to calculate how much you have earn, you can make use of the formula to convert an APR to APY base on the frequency of compounding. For instance, A 20% APR with a monthly compounding is equasl = 21.94% in APY. For a daily compounding it would be equals = 22.13% APY. The APY numbers is to represent the annualized interest returns that you earn after the incorporating of the compound interest.

In total amount, APR (annual percentage rate) isn't difficult to calculate since it is usually quoted as a fixed yearly rate.

How to compare different interest rates?

From the given example you have read above, you can see that more interest be can be earned when in is compounded. However, different financial products may stipulate their rates as either APY or APR. Always be mindful when you're comparing products.

Products with a higher APY (annual percentage yield) may not necessarily yield you more interest compare to those products that has lower APR (annual percentage rate). However, you can convert APR and APY easily by using online tools if only you know the frequency of the compounding interest that is stipulated.

The same method goes for DeFi (decentralized finance) products and other crypto products. Like the best way you can get a good crypto APY and APR, is via crypto savings and crypto staking which Binance exchange offers to it users and also you can access such in other exchanges.

Additionally, when you are comparing two DeFi products with APY, you should make sure that they both have the same compounding periods. In a case where they both have the same both one is compounds daily and the other is monthly, then you should know that the one that is compound daily would earn you a higher crypto interest than the one that is compounds monthly.

Fourthly friend, it is very important for you to know what APY stands for in relation to the specific crypto product you are reviewing or about to subscribe to. Some collaterals of crypto product make use of the word "APY" to refer to the rewards that you can earn in Crypto over the selected timeframe that is stipulated and not the actual in any fist currency. This is very important for you to always check the crypto products before jumping to accept the terms and conditions of the products because the price of cryptocurrency is highly volatile.

Conclusion:

APY and APR are two different terms that are sometime confusing, as we often come across them in DeFi products and even in our financial institutions. However, in this post I believe that you have now know that APY is usually a higher number when interest is compounded often than once a year, whereas, APR is the interest that is earn daily, weekly, monthly or yearly.

Disclaimer: All what you have read are purely present to you as an educational information to expose you to how interest is earn in both DeFi and Centralized Finance system and not a financial advice. However, I will appreciate your questions at the comments section.

You can also reading about how to balanced a well portfolio below.

How to build a well balanced crypto portfolio