I notice that the Derbyshire BS fixed rate bonds offer an annual interest or a monthly interest account. The gross/AER for the yearly paid interest (on savings over 5k) is 5.30% and for the monthly paid interest it is 5.20% gross & 5.33% AER. Sorry if I appear thick here but I thought that yearly paid interest accounts paid better AER than monthly? I'm looking at setting up a 3 year fixed rate bond for a non-tax payer, for the best return would that be the monthly interest account but leaving the interest in the account to grow?
Derbyshire BS monthly or yearly interest?
Jan 24, 2005
6 Replies
In message , Mark writes
Not necessarily. The nominal rate is usually higher, but the AER is usually pretty much the same, but this is a case where the AER is more misleading than it is helpful because it assumes the interest is paid on days that it isn't.
The bond isn't for 3 years, its until 29 Feb 2008 and the annual interest is paid at the end of Feb starting with this year, but the monthly interest account pays interest on the 15th of each month. So that means if you invest before the 28 Jan you will get one months interest compounding at 5.3% per annum instead of 5.2%. This gives you a head start on the first month, but the monthly interest compounds monthly on the 15th.
The effect of the first month gives the annual scheme a head start, but the higher the interest rate the quicker it loses it. So, if you receive interest gross then go for monthly interest being re-invested and on 29 Feb 2008 you will be .076% better off in total than with annual interest, but if you receive your interest net of tax then go for annual compounding and you will be (in total) .007% better off at maturity than monthly.
The longer you leave it the worse you will be, Pip Pip!
Are you sure you copied those figures down correctly *and* that you copied them from a reliable source?
5.20% gross pa paid monthly is equivalent to an AER of 5.30%, not 5.33%.Some banks/BSs do tend to offer the same AER on yearly and monthly options, and that means the contract gross annual rate for the monthly account must be less than that for the yearly one (as it is here, i.e.
5.2% vs 5.3%). 5.20% gross pa is 0.4333% gross pm, or 0.3467% net pm. This compounds to 4.240% net pa, equivalent to 5.300% gross pa.Yes, but confirm with the BS that they would indeed be paying 0.4333% each month (provided the saver filled in the appropriate tax form allowing interest to be paid without deduction of tax), and which would then compound in subsequent months. If so, it would actually come to an effective annual rate of 5.33% (5.326% to be more precise), but this is not an AER, since the definition of AER involves taking off 20% tax at each instance where interest is credited, and then re-expressing the compounded net result back in gross terms.
The E in AER stands for "equivalent", not "effective".
I checked at
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You dont have enough info to make that calculation/ You havent checked when the interest is paid.
You are falling into the 'working the rate back from the APR trap' again.
Where did you get this from?
Correct. I made the default assumption that annual interest payments are in phase with the monthly ones. If that is not the case with this particular product, you would indeed expect a small discrepancy.
I'm not convinced that this effect is to blame here, I think they've just taken (1+0.052/12)^12-1 and come up with 0.053257 and rounded it to 5.33%.
Certainly not. I was calculating forwards to the AER by working from the *contract nominal* rate given, i.e. 5.2% nominal pa paid and taxed as a twelfth of that each month.
I'd have hoped it would be implicit, but if not, the AER really only makes sense in terms of non tax payers (who are presumably in the minority of savers). Thus it makes the whole concept of AER almost useless for the majority of savers (I'm assuming the majority of savers are standard rate taxpayers), since it makes it more difficult if not impossible to compare the effect of deciding which product represents better value *to them*, which of course must mean *net* value.
It is an inescapable fact that interest payments are taxed when paid, so the amounts taken out as tax when interest is paid monthly are not available to contribute to compounding during the year. This means that to a "normal" saver who has interest deducted at source, a 5.2% monthly account is only worth (1+0.052*0.8/12)^12-1 = 4.24024%, which happens to be about the same as what a 5.3% annual account is worth (4.24000%).
Yet DBS's table purports to show that the 5.2% monthly account, at a
5.33% AER, is a full 0.03% more valuable than the 5.3% annual account, which is an unhelpful exaggeration, suggesting that on a £10k deposit, after a year, a saver would be £3 better off before tax (though actually because of the rounding it would only be £2.57), with the monthly option than with the annual option, whereas in fact he's only 0.00024% of £10k better off after tax (3p before tax).
That makes it more clearer, thanks for that.
Thats what I mean. I.e. you have to make assumptions that need not be correct, as in this case.
No, its explicitly not -
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Agreed. Surprisingly, it wasnt the government who thought it up either.
I agree. It would be better to scrap AER and go back to the way it used to be.
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