Monthly vs Annual Interest

allisond

Hi
I'm a newbie to the forum, so I apologise if this question has already been asked - I couldn't find any previous threads!!

Sorry if I am being thick, but is it better to have a savings account that pays 6.5% monthly interest or an account that pays 10% annual interest. I am thinking of the monthly interest on interest - whether this works out to be better.

I have a lump sum to invest plus regluar monthly savings to top it up.

Thanks for any advice given.

Allison

Aegis

10% annual would get a much better return than 6.5% monthly. Compounding doesn't have enough of an effect to mitigate the much higher rate in this example.

Mikeyorks

And, if you're a taxpayer, the 20% deducted from the monthly interest introduces a mild drag factor on the compounding. So 6.5% annual is marginally better than 6.5% monthly ............ but the 10% is infinitely better than either!

And particularly if you're feeding a 10% Regular Saver with 'new money' direct from income - as you appear to suggest? As the 10% isn't mitigated in any way by being fed from a lower interest account.

danielkian

Please could you detail the maths in working out compund versus annual interest? A while back i was comparing annual interest of 6.13% with monthly interest of 5.94. Someone advised that 5.94 monthly was better, but you seem to be suggesting this is not the case? Your help is appreciated. Thank you.

Aegis

AER = annual gross interest where interest is paid monthly

AER = (gross interest rate / 12)^12 for monthly compounded interest

As such, if you have gross interest of 6% paid either monthly or annually, it will be 6% AER if paid annually and 6.17% AER if paid monthly.

danielkian

Thanks for that. I am still slightly concerned about the 20% tax 'drag factor' on monthly interest that is mentioned? As maths is admitedly not my strong point, how do i take that into account? Thanks again.

danielkian

Actually - i suppose marginal difference (as quoted above) is just that, so think i've answered my own question, as much as i need to meet my own needs.

oldfella

check the AER - if the AER for monthly and annual interest is the same, then you are better going for annual because of the loss of compound interest on the monthly tax deduction.

allisond

Thanks to everyone for your input, it is much clearer now.

I'm not a tax payer, as i have 2 young children to look after, my husband is though, but i am making the most of the gross interest at the moment by having all of our savings in my name.

I have 30k to put somewhere, does it still work out better using a 10% account, as you can only put a small deposit in & a small amount in each month? Whereas i could get 6.5% on the entire 30k plus monthly interest?

All advice appreciated.

free4440273

another good example is the much discussed halifax regular saver paying ten per cent: even if one were to transfer the full maximum £6000 into the account over 12 monthly installments, this would not earn you anything like the ten per cent annual interest on the total sum (of £6000).

jamesd

allisond, you put the money where it makes the most then you transfer from that to put the maximum amount each month into the 10% one. The interest you receive on the money going into the 10% one will end up being a bit more than the average of the rates for the two accounts: so one at 6.5% and one at 10% means that over the whole year you'd get about 8.25% on the money that is in the 10% one at the end of the year.

A more accurate calculation is 6.5 times the regular saver rate plus 5.5 times the other rate then divide that by 12: (6.5 * 10 + 5.5 * 6.5) / 12 = 8.4%

If you could put in 500 a month you'd have 6000 at the end of the year and would have made 8.4% on that, or 504 Pounds.