Recently, I’ve been chatting with many friends about investing and lending, and I’ve found that everyone often gets APR and APY mixed up. In fact, understanding both is quite important—it directly affects your returns or costs.

First, let’s talk about what annual interest rate is. APR is simply the annual interest rate, where interest is calculated only on the principal and compounding isn’t considered. You often see it on credit cards, consumer loans, or mortgages, and the bank will clearly tell you “annual interest rate”—it sounds straightforward, right? But that’s also where the problem lies: it ignores the key factor of compounding, so the actual annual return is often higher or lower than the APR, depending on how frequently interest is compounded.

APY is different. It’s the annual yield rate, which includes the compounding effect. Imagine that your interest doesn’t just earn based on the principal—it also earns on the interest you’ve already made, and this continues compounding over time. After a year, your earnings will be higher than with a simple annual interest rate. Bank deposits, funds, and even cryptocurrency staking are often expressed using APY, because this number more accurately reflects how much your money can actually grow.

The key difference is here: what is the annual interest rate? It’s just the baseline, but APY is what you truly get to take home. The higher the compounding frequency is (for example, calculating once per day), the bigger the gap between APY and APR. So when investing, make sure you clearly understand which one you’re looking at—don’t be misled by the numbers. Choose the right indicator, and your returns can be maximized.