What Is The Annual Equivalent Rate (AER)?
- The annual equivalent rate (AER) is the interest rate for a savings account or investment product that has more than one compounding period. AER is calculated under the assumption that any interest paid is included in the principal payment's balance and the next interest payment will be based on the slightly higher account balance. The AER method m...
Formula For The Aer
- Annual equivalent rate=(1+rn)n−1where:n=The number of compounding periods (times per year …
How to Calculate The Aer
- To calculate AER: 1. Divide the stated interest rate by the number of times a year that interest is paid (compounded) and add one. 2. Raise the result to the number of times a year that interest is paid (compounded) 3. Subtract one from the subsequent result. The AER is displayed as a percentage (%).
Annual Equivalent Rate vs. Stated Interest
- While the stated interest rate doesn't account for compounding, the AER does. The stated rate will generally be lower than AER if there's more than one compounding period. AER is used to determine which banks offer better rates and which investments might be attractive.
Advantages and Disadvantages of The Aer
- The primary advantage of AER is that it is the realrate of interest because it accounts for the effects of compounding. In addition, it is an important tool for investors because it helps them evaluate bonds, loans, or accounts to understand their real return on investment (ROI). Unfortunately, when investors are evaluating different investment options, the AER is usually no…
Special Considerations
- AER is one of the various ways to calculate interest on interest, which is called compounding. Compounding refers to earning or paying interest on previous interest, which is added to the principalsum of a deposit or loan. Compounding allows investors to boost their returns because they can accrue additional profit based on the interest they've already earned. One of …