What is AER?
Annual Equivalent Rate (AER) can help you to understand how much money you'll make on your savings account over a year.
In this guide
AER can be complicated to work out - but we're here to guide you through it. In this guide, you'll discover:
- The basics of AER
- Interest, savings and AER
- The value of AER
The basics of AER
AER shows you what you would earn in interest on savings over the course of a year as a percentage.
When shopping around for a new savings account, AER can help you to compare different saving or investment options.
It's useful to know that AER accounts for compound interest, which is interest earned in addition to any interest already paid, but it does not account for fees and charges associated with accessing or managing your savings.
Interest, savings and AER
When you put money aside in savings, your bank may reward you by paying you interest. That’s usually a percentage of any money you’ve held with them for a full calendar year.
AER represents this. The higher the percentage, the more interest you can expect to earn on your savings.
AER can apply to a wide range of savings products, including:
The amount and regularity of interest payments will depend on the bank or building society, and the terms of the account you select.
Just as an example, fixed ISAs tend to offer higher AER interest returns, but your money may be locked in for longer. Charges or penalties may apply for withdrawing your savings earlier. On the other hand, an instant access ISA gives more flexibility, but lower AER interest returns.
Investments can also be subject to other factors, such as business performance and fluctuations in the stock market, making the potential returns less predictable.
Benefit from tax-free savings by using your yearly Personal Savings Allowance of up to £1,000, and saving up to £20,000 using your yearly ISA allowance.
However you choose to save, it’s important to consider:
- how much tax you might have to pay on any gains
- whether you need regular access to your savings pot
- whether you can afford to lock your savings in to earn a higher AER
- how much risk you’re prepared to accept in the hopes of earning at a higher interest rate.
It’s worth comparing several options to find one that suits your needs best, which is where the AER comes in handy. Whatever you choose, you usually don’t have to do much more than have your money in a savings account to start earning interest.
Understanding the value of an AER
Working out AER can get a little complicated, as it’s influenced by several factors:
- The total (gross) interest earned over a year.
- The effect of compound interest.
- How often the bank pays interest – for example it could be monthly, bi-annually or annually.
You’ll see AER displayed as a percentage – 1.5%, for example. By depositing and holding £100 with a bank offering 1.5% AER, after a year you’d get £1.50.
Just as an example, let’s say you’re able to deposit and hold £2,000 in a savings account offering 2% AER. Accounting for compound interest, your earnings over a 5-year period could look like:
|
Year |
Interest |
Total interest |
Balance |
|---|---|---|---|
|
Year 1 |
Interest £40 |
Total interest £40 |
Balance £2,040 |
|
Year 2 |
Interest £40.80 |
Total interest £80.80 |
Balance £2,080.80 |
|
Year 3 |
Interest £41.61 |
Total interest £122.41 |
Balance £2,122.41 |
|
Year 4 |
Interest £42.44 |
Total interest £164.85 |
Balance £2,164.85 |
|
Year 5 |
Interest £43.29 |
Total interest £208.16 |
Balance £2,208.16 |
You can see that any interest that your bank pays you becomes part of your balance and you start earning interest on the total. Over time, compound interest can help your savings to grow faster.
Advantages and drawbacks
Pros
- Because it includes the effect of compound interest, AER gives you a realistic view of the interest you could earn. But there are other factors you should bear in mind.
- AER gives you a realistic impression of your potential returns on savings and helps you compare savings or investment options.
Cons
- AER does not account for any fees or charges related to accessing or managing your savings.
- It also does not feature alongside all investment products, so investors need to determine the potential returns themselves.
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