Question about compound interest

Arnie22

Having read the article on the main site, I thought I understood compounding, and the reason why AER is different for interest credited annually or monthly. However, I have just been reading the small print of the SAGA fixed rate account, which states that interst is calculated daily. Can anybody explain what is meant by this? I expected it to be calculated either monthly or annually for the two acounts on offer.

BruceyBonus

By having it calculated daily (as virtually all accounts do), it means that you earn interest on the "average" balance on your account, not just on the day they calculated the interest. This takes into account the length of time money was in your account.

E.g. if they calculated interest annually on 1st Jan, you could (in theory) leave £1 in account all year, then on 31st Dec pay in £10,000. 2nd Jan withdraw the £10,000 and you would be paid a whole year's interest on the money. By calculating the interest daily, it prevents this from happening by only giving you one day's interest if you were to do this!

LittleVoice

"Calculated" is not the same as "paid".

Calculated means that the amount in the account each day forms the capital for the calculation and the equivalent of all the days' interest is added to produce the amount which will be paid monthly, annually or at whatever other point it becomes due.

YorkshireBoy

Arnie22 wrote: »

...the reason why AER is different for interest credited annually or monthly.

You'll find, 99% of the time*, that the AER remains the same...whether you opt for monthly or annual interest. It's the 'gross p.a.' rate that will be different.

AER is purely an illustrative figure which allows you to compare accounts. You'll always earn interest at the 'gross p.a.' rate quoted.


* Some exceptions being where an introductory rate applies, an 'until' end date (where the AER decreases with each month that passes) exists, or where the provider takes a decision to pay a different AER for one or the other accounts they offer.