Annual Equivalent Rate (AER)

The Annual Equivalent Rate (AER) is a standardized measure of interest rate that reflects the actual return on an investment or the actual cost of a loan on an annual basis, taking into account the effects of compounding. AER is particularly useful for comparing savings accounts, bonds, or other interest-bearing products that have different compounding periods. It shows the true annual rate at which interest is earned or paid, allowing consumers and investors to make informed decisions.

Example

If a savings account offers an interest rate of 4% compounded quarterly, the AER might be slightly higher than 4%, reflecting the effect of compounding interest over the year.

Key points

• A measure of the true annual interest rate, accounting for compounding.

• Used to compare the returns on savings accounts, bonds, and other interest-bearing products.

• Expressed as a percentage, showing the actual annual rate of return.

Quick Answers to Curious Questions

What is the Annual Equivalent Rate (AER)?

AER is the true annual interest rate that reflects the actual return on an investment or the actual cost of a loan, accounting for the effects of compounding.

Why is AER important for comparing financial products?

AER allows consumers and investors to compare different savings accounts or loans on an equal basis, understanding the true annual return or cost.

How does compounding affect AER?

Compounding increases the AER, as it reflects the interest earned on previously earned interest, providing a more accurate picture of the annual return or cost.