Stated Annual Interest Rate

Stated Annual Interest Rate
The return on an investment that is expressed as a per-year percentage, and that does not account for compounding that occurs throughout the year. The effective annual interest rate, on the other hand, does account for intra-year compounding that can occur on a daily, monthly or quarterly basis. Typically, the effective annual interest rate will lead to higher returns than the stated annual interest rate due to the power of compounding. Investors can compare products and calculate which type of interest will offer the most favorable return.

A \$10,000, one-year certificate of deposit with a stated annual interest rate of 10% will earn \$1,000 at maturity. If the money was placed in an interest-earning savings account that paid 10% compounded monthly, the account will earn interest at a rate of 0.833% each month (10% divided by 12 months; 10/12 = 0.833). Over the course of the year, this account will earn \$1,047.13 in interest, at an effective annual interest rate of 10.47%, which is notably higher than the returns on the 10% stated annual interest rate of the certificate of deposit used in the example.

Investment dictionary. . 2012.

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