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.)
RELATED FAQS

What is the variance/covariance matrix or parametric method in Value at Risk (VaR)?
Learn about the value at risk and how to calculate the value at risk of an investment portfolio using the variancecovariance, ... 
What is backtesting in Value at Risk (VaR)?
Learn about the value at risk of a portfolio and how backtesting is used to measure the accuracy of value at risk calculations. 
How much variance should an investor have in an indexed fund?
Learn more about the significance of variance in index funds, its value as a measure of volatility and other common analytical ... 
Can the correlation coefficient be used to measure dependence?
Understand the coefficient of correlation and its use in determining the relationship between two variables through the concepts ...

Compound Annual Growth Rate  CAGR
The yearoveryear growth rate of an investment over a specified ... 
MeanVariance Analysis
The process of weighing risk against expected return. Mean variance ... 
Systematic Sampling
A type of probability sampling method in which sample members ... 
Variance
The spread between numbers in a data set, measuring Variance ... 
Leptokurtic
A statistical distribution where the points along the Xaxis ... 
Platykurtic
A type of statistical distribution where the points along the ...