Confused about daily interest and compound interest

Hoenir

wmb194 said:

Hoenir said:

Interest isn't added daily to the account. Interest is calculated daily. What's key is how often it is paid to the account holder.

The OP might have Trading212's GIAs and S&S Isas in mind as they credit interest daily.

Hence my comment about when it's actually paid. As this will determine the compounding of the interest as opposed to the accruing (which is an accounting concept).

AmityNeon

surreysaver said:

reg091 said:

eskbanker said:

reg091 said:

Forget about the interest rate, is my assumption that the only account that pays compounded interest one that pays daily?

No, the vast majority of accounts (except those that insist on interest being paid away) will compound interest, whether credited daily, weekly, monthly or annually, but the key message is that this isn't some money-making wheeze, as the interest rate paid will be calibrated according to the frequency. In other words, the gross rate paid will be lower the more frequently it's paid, and, as above, the basis on which to compare is the AER, which factors compounding into its derivation in order to allow a standardised like-for-like comparison of the actual annual return.

Brilliant, thanks! So, if you had £1000 in each of three accounts, each with the same AER, and one crediting interest daily, one monthly and one annually, you would make the same exact amount of interest from each after 12 Months?

Unless you withdraw money. It may also affect how much tax you pay if some interest is credited one tax year and the rest the next.
If you withdraw money before interest is added, you may be better off with an account paying interest less frequently, as that will have a higher gross rate, even if the AER is the same.

Making withdrawals (and no deposits) is the one scenario where more frequent interest credits results in higher total gross interest after 12 months because the interest from higher balances in earlier periods can still compound for the rest of the term.

Assuming the AER is 5%, 6 months of £1,000 plus 6 months of £500 makes no difference with annual interest, regardless of when those months take place in the annual period; the result will always be around £37.50.

For monthly (or daily) interest, the first 6 months at £1,000 followed by the latter 6 months at £500 will yield more than £37.50, whereas if the order were reversed with the first 6 months at £500 and then increasing to £1,000 for the latter 6 months (i.e. a deposit instead of a withdrawal), the total gross interest would be less than £37.50. If there were frequent withdrawals alternating with deposits (e.g. -£500 +£500 yo-yoing), the result would be much closer to £37.50.

Realistically, in practical terms, the most important consideration is when interest arises for tax purposes, as potential tax would likely dwarf the minimal mathematical differences (which are also affected by rounding and the differing number of days each calendar month)

wmb194

Hoenir said:

wmb194 said:

Hoenir said:

Interest isn't added daily to the account. Interest is calculated daily. What's key is how often it is paid to the account holder.

The OP might have Trading212's GIAs and S&S Isas in mind as they credit interest daily.

Hence my comment about when it's actually paid. As this will determine the compounding of the interest as opposed to the accruing (which is an accounting concept).

Right, but with T212 it's actually paid daily. There have been a few threads from new savers/investors who were under the impression that this is normal.