Recently, someone asked me what exactly the annual percentage rate (APR) means, and I found that many people actually confuse APR and APY. These two concepts are really quite different in investing and lending.

Let's start with APR, which is the annual interest rate. The calculation is very simple, based solely on your principal, without considering compounding. If you borrow or invest money, APR directly tells you how much interest you'll pay or earn in a year. Credit card rates, consumer loans, and mortgages are usually expressed using APR. But there's a problem here: because APR doesn't include compounding, it doesn't accurately reflect your true annual return.

APY, on the other hand, is called the annual yield, and it fully incorporates the effects of compounding. The power of compounding is that you can earn interest not only on your principal but also on the interest you've previously earned. Bank deposits, funds, and cryptocurrency staking all use APY because the interest is compounded daily, monthly, or quarterly. So under the same interest rate conditions, APY is usually higher than APR and more accurately reflects how much your investment will actually grow.

The key to understanding what annual percentage rate means is this: APR is a simple calculation, while APY accounts for compounding. If you're looking at investment products or loan terms, be sure to check whether they use APR or APY, as this will directly affect how much you can ultimately earn or owe. Especially in scenarios like staking or deposits that generate compound interest, APY is the number you truly need to pay attention to.