Monthly Interest vs Annual interest

JohnKellett

Hi all - a couple of quick questions regarding monthly interest.

1) What is the advantage of having monthly interest at an AER of 2.15% compared to annual interest at AER 2.50% ?

2) Why is the following calculation wrong:

For the period between 18 Dec 06 and 16 Jan 07 (on which dates interest was paid), my account balance stayed constant at £6476.64. The monthly interest rates on the account from 1 Dec 06 until 31 Jan 07 stayed constant at 2.25% AER, 2.23% Gross, 1.78% Net. So by my calculation, on 16 Jan I should have received interest as follows:

(1.0178)^(1/12) = 1.00147136.......
0.00147136....... x 6476.64 = 9.5295.... ~ £9.53

However, I only received £9.18. How did my bank arrive at this figure (i.e. what have I/they done wrong?)

Thanks for your help folks!!

JK

nilrem_2

AFAICS you have £6476.64 X 1.78% = £115.28 divided by 365 = 0.3158p X 29days = £9.16. Near enough IMHO.

JohnKellett

Hmmmm, not sure about that. If the calculation is right, the figure should be exact. And that doesn't take any compund effects into account.

Also it should be a whole month's interest taht went in shouldn't it (should be paid on the 16th, but the 16th Dec was at the weekend)

Thanks anyway though - can anyone else see what's wrong?

JK

debbie42

JohnKellett wrote: »

Hi all - a couple of quick questions regarding monthly interest.

1) What is the advantage of having monthly interest at an AER of 2.15% compared to annual interest at AER 2.50% ?

2) Why is the following calculation wrong:

For the period between 18 Dec 06 and 16 Jan 07 (on which dates interest was paid), my account balance stayed constant at £6476.64. The monthly interest rates on the account from 1 Dec 06 until 31 Jan 07 stayed constant at 2.25% AER, 2.23% Gross, 1.78% Net. So by my calculation, on 16 Jan I should have received interest as follows:

(1.0178)^(1/12) = 1.00147136.......
0.00147136....... x 6476.64 = 9.5295.... ~ £9.53

However, I only received £9.18. How did my bank arrive at this figure (i.e. what have I/they done wrong?)

1) An AER is the rate to be used when comparing two savings accounts, regardless of whether the interest is paid monthly or annually. If you aren't bothered about when you get your interest then, all other things being equal, you'd go for the higher rate.

2) Your calculation assumes it's a full months worth of interest, when it isn't quite. Also, to be exact, it depends how the interest is compounded (monthly/daily), and when.

Whichever way you look at it, 2.25% AER is a pretty poor rate of interest for savings!

(edit: just out of interest, I made it £9.16 with my spreadsheet, allowing for daily interest, but not allowing for compounding. )

YorkshireBoy

JohnKellett wrote: »

...the figure should be exact.

Ok then, try this...

For an account paying interest monthly, you need to use the gross p.a. rate to calculate the daily interest.

So, assuming 29 (interest earning) days...

£6,476.64 x 2.23% / 365 x 29 x 0.8 = £9.180149233972602

Or £9.18 to 2 decimal places.

Is that "exact" enough for you?

JohnKellett

Bingo! Thanks YB, I think that's the calculation I needed. I take it the tax rate is 20%? In which case, the 2p discrepancy in the calculation using the net pa rate arises because 0.8 * 2.23 = 1.784 rather than 1.78.

But nobody has yet given me a reason to earn monthly interest at a lower rate than I could get with annual interest. It seems to me that this is a clever scheme on the part of the bank - quote the higher annual AER rate in their publicity material, then get people to sign up to the lower monthly AER rate. I think my bank manager might be getting a visit..........!

PS - " Is that "exact" enough for you?" - It's not that I'm concerned about 2p here or there, but the fact that the figure was even slightly wrong indicated that the calculation wasn't correct somewhere.

YorkshireBoy

JohnKellett wrote: »

But nobody has yet given me a reason to earn monthly interest at a lower rate than I could get with annual interest. It seems to me that this is a clever scheme on the part of the bank - quote the higher annual AER rate in their publicity material, then get people to sign up to the lower monthly AER rate.

I'm not sure I follow your logic, or indeed that you're comparing like for like.

AER's should be used to compare account returns. If the interest is paid annually, and there are no introductory rates on the account, then the AER is the same as the gross p.a. figure.

If the account pays interest monthly, and again if there are no introductory rates, then the gross p.a. rate will always be less than the AER, and it's this gross p.a. rate that should be used to calculate the daily interest (as I demonstrated above). If you do not withdraw this interest paid each month, and leave it to 'compound', then the total interest paid at the end of the year will be the AER quoted.

In fact, it has been demonstrated by the mathematicians on here that annual interest gives a marginally better return due to the taxation each month on the monthly paid interest. However, this equates to pennies over a year.

JohnKellett

Well the account I have has an AER of 2.60% for annual interest payments, and an AER of 2.25% for monthly payments... so am I being ripped off by having monthly payments?

YorkshireBoy

JohnKellett wrote: »

Well the account I have...

Which account/provider?

JohnKellett

It's a Gold Saver with Lloyds. (the rates I quoted are out of date now, but apply to the calculation above)

YorkshireBoy

JohnKellett wrote: »

It's a Gold Saver with Lloyds.

You won't believe this, but while you were responding I googled "2.60% 2.25% AER" and one of the first hits was LTSB!!

I don't recall ever seeing an account that penalises a customer so much for taking their interest monthly. Was it originally a passbook account, or indeed a very old account?

Anyway, you need to move your money John. Whichever rate you use, those are terrible returns on what is not a small amount of money.

For your information...

• BOE base rate is currently 5.50%
• 'Real' inflation (depending on your age/circumstances) could be as high as 4.8%
• You could be getting 6% and more with some providers now.

BTW, you can't really blame the bank/manager. It's your responsibility to check the rates - at least once or twice a year, and certainly after each BOE rate change.