AER - help please

gelato_cat

Hi there

I've got a new savings account and the AER is 5.25%.

If I get my interest paid annually, the gross rate is 5.25%. However, if it's paid monthly, the gross rate is 5.13%.

I can't work out whether it's better to get it monthly or annually. Surely it's about the same because the AER is the same?

Any ideas?

Suze

codetown

Suzey wrote:

I can't work out whether it's better to get it monthly or annually. Surely it's about the same because the AER is the same?

If you leave the interest gained in the account, then it will also gain interest (composite interest), so if the AER is the same the total you will have after a year is exactly the same.

Monthly interest is useful to those who will take the money and widraw or even have there just in case of unexpected expenses (while with annual interest your interest is not usable at all!).

If the AER is the same, go for the monthly interest.

gelato_cat

Hi

This is what my information sheet says:

Annual interest rate:
AER 5.25%
Gross pa 5.25%
Net pa 4.20%

Monthly interest rate:
AER 5.25%
Gross pa 5.13%
Net pa 4.10%

Variable interest paid either annually or monthly (at a lower rate).

So the AER is the same for both but the gross is different.

I've chosen to receive my interest monthly but I'm still confused as to whether or not this was a good idea.

Suze

codetown wrote:

If you leave the interest gained in the account, then it will also gain interest (composite interest), so if the AER is the same the total you will have after a year is exactly the same.

Monthly interest is useful to those who will take the money and widraw or even have there just in case of unexpected expenses (while with annual interest your interest is not usable at all!).

If the AER is the same, go for the monthly interest.

grumbler

codetown wrote:

If you leave the interest gained in the account, then it will also gain interest (composite interest), so if the AER is the same the total you will have after a year is exactly the same.

Absolutely!
(1+5.13%/12)^12-1=5.25%

tomstickland

It's fine. The annual return will be the same if you leave the money in for a year.


AER = 100*(( 1 + gross_%/1200)^12 - 1 )
which turns 5.13% gross into 5.25 annual.
The logic is pretty simple. You get 1/12th of the gross rate per month, but it compounds twelve times.

gelato_cat

Thanks for the equations - all makes sense now

Suze

SeanW

If you pay tax you will get less by receving interest monthly.

This is because tax is deducted for each interest payment, therefore the compounding effect is less as you are earning interest on interest that has had some removed.

Also, if you are not putting in a lump sump, but are putting money in regularly, or randomly, you will not have the interest there to have the compounding effect, therefore you are better receving it annually.

e.g. putting £1000 in month 12, this would get approx £4.26 if paid monthly, but a massive £4.38 if paid annually.

gelato_cat

Thanks - realised the tax issue when I came across another thread

Not sure about the lump sum thing - if the money isn't there, it can't receive interest no matter what the frequency, no?

Suze

SeanW wrote:

If you pay tax you will get less by receving interest monthly.

This is because tax is deducted for each interest payment, therefore the compounding effect is less as you are earning interest on interest that has had some removed.

Also, if you are not putting in a lump sump, but are putting money in regularly, or randomly, you will not have the interest there to have the compounding effect, therefore you are better receving it annually.

e.g. putting £1000 in month 12, this would get approx £4.26 if paid monthly, but a massive £4.38 if paid annually.

SeanW

Not sure about the lump sum thing - if the money isn't there, it can't receive interest no matter what the frequency, no?

The monthly rate applied to an account is lower, so that when compounded, it makes it up to the annual rate. This is because you earn interest on interest.

If you put money in month 12, and only had £1 in before that, you would get less interest on the monthly option because, because the rate for that month would be approx 0.4275%. For the annual option, the rate for that month would be approx 0.4375%. This is trivial for small sums and my example however, about 15p.