Essentially, the effective annual return accounts for intrayear compounding, and the stated annual return does not.
The difference between these two measures is best illustrated with an example. Suppose the stated annual interest rate on a savings account is 10%, and say you put $1,000 into this savings account. After one year, your money would grow to $1,100. But, if the account has a quarterly compounding feature, your effective rate of return will be higher than 10%. After the first quarter, or first three months, your savings would grow to $1,025. Then, in the second quarter, the effect of compounding would become apparent: you would receive another $25 in interest on the original $1,000, but you would also receive an additional $0.63 from the $25 that was paid after the first quarter. In other words, the interest earned in each quarter will increase the interest earned in subsequent quarters. By the end of the year, the power of quarterly compounding would give you a total of $1,103.80. So, although the stated annual interest rate is 10%, because of quarterly compounding, the effective rate of return is 10.38%.
That difference of 0.38% may appear insignificant, but it can be huge when you're dealing with large numbers. 0.38% of $100,000 is $380! Another thing to consider is that compounding does not necessarily occur quarterly, or only four times a year, as it does in the example above. There are accounts that compound monthly, and even some that compound daily. And, as our example showed, the frequency with which interest is paid will have an effect on effective rate of return.
(To read more, see Projected Returns: Honing The Craft.)

Other than my savings account, what other types of holdings compound my interest?
Understand the benefits of compounding interest, and learn the types of investments that offer compounding in addition to ... Read Answer >> 
What formula can I use to calculate interest on interest?
Find out more about compounding interest, what it measures and how to calculate the amount of compound interest accrued using ... Read Answer >> 
How often is interest compounded?
Understand what compound interest is and how the compounding of interest applies to the benefit of investors or creditors, ... Read Answer >> 
How do mutual funds compound interest?
Learn how mutual funds can grow wealth over time through the magic of compound interest by reinvesting dividends back into ... Read Answer >> 
What is continuously compounding interest?
Read a quick explanation of continuously compounding interest rates, why compounding matters and how to calculate the continuous ... Read Answer >>

Investing
Accelerating Returns With Continuous Compounding
Investopedia explains the natural log and exponential functions used to calculate this value. 
Investing
Overcoming Compounding's Dark Side
Understanding how money is made and lost over time can help you improve your returns. 
Investing
The Effective Annual Interest Rate
The effective annual interest rate is a way of restating the annual interest rate so that it takes into account the effects of compounding. 
Investing
How does Compound Interest Work?
A quick way to understand the impact of compound interest is to ask yourself if youâ€™d rather receive $100,000 a day for a month, or start with a penny on day one and double it every day for those ... 
Personal Finance
How Interest Rates Work on Savings Accounts
Here's what you need to know to grow your rainyday fund. 
Investing
Learn Simple And Compound Interest
Interest is defined as the cost of borrowing money, and depending on how it is calculated, can be classified as simple interest or compound interest. 
Retirement
Why Investors Should Care About Compound Interest
Learn about compounding interest and how it impacts savings decisions, debt management, investment strategies and retirement planning. 
Personal Finance
APR and APY: Why Your Bank Hopes You Can't Tell The Difference
Banks use these rates to entice borrowers and investors. Find out what you're really getting. 
Investing
How To Calculate Your Investment Return
How much are your investments actually returning? Find out why the method of calculation matters. 
Retirement
What Your 401(k) Can Look Like in the Next 20 Years
Discover how time and compounded growth of earnings can help even a modest 401(k) plan balance grow to a significant sum over a period of 20 years.

Stated Annual Interest Rate
The return on an investment that is expressed as a peryear percentage, ... 
Effective Annual Interest Rate
Effective Annual Interest Rate is an investment's annual rate ... 
Compound Return
The rate of return, usually expressed as a percentage, that represents ... 
Compound Interest
Compound Interest is interest calculated on the initial principal ... 
Discrete Compounding
Discrete compounding refers to the method by which interest is ... 
Annual Percentage Yield  APY
The effective annual rate of return taking into account the effect ...