Annual Equivalent Rate

Short Answer
The Annual Equivalent Rate (AER) is the effective interest rate on savings or investments over a year, taking into account the effect of compounding.

Annual Equivalent Rate

Definition

The Annual Equivalent Rate (AER) is a standard measure of interest rates that reflects the true annual rate of return on savings or investments, considering the effect of compounding interest. AER is used to provide a clear and comparable way of understanding the interest earned over a year, even if interest is paid more frequently, such as monthly or quarterly.

AER helps savers and investors compare different financial products with varying compounding periods. It assumes that the interest earned is reinvested and compounded over the year, providing a more accurate picture of the actual returns. The formula for AER takes into account the nominal interest rate and the number of compounding periods per year, allowing for easy comparison across different savings accounts, bonds, and other interest-bearing products.

Annual Equivalent Rate

Examples

  1. A savings account offering a nominal interest rate of 2% compounded monthly might have an AER of 2.02%.
  2. A bond with a nominal interest rate of 3% compounded semi-annually might have an AER of 3.03%.
  3. A certificate of deposit (CD) with a nominal interest rate of 1.5% compounded quarterly might have an AER of 1.51%.

Annual Equivalent Rate

Further Reads

  1. Understanding AER - Investopedia
  2. How AER Works - The Balance
  3. AER and Savings Accounts - Bankrate

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