What is a 'Stated Annual Interest Rate'

A stated annual interest rate is the return on an investment (ROI) that is expressed as a per-year percentage. It does not account for compounding that occurs throughout the year. The effective annual interest rate, on the other hand, does account for intra-year compounding, which can occur on a daily, monthly or quarterly basis. Typically, the effective annual interest rate will lead to higher returns than the stated annual interest rate due to the power of compounding. Investors can compare products and calculate which type of interest will offer the most favorable return.

BREAKING DOWN 'Stated Annual Interest Rate'

A $10,000, one-year certificate of deposit (CD) with a stated annual interest rate of 10% will earn $1,000 at maturity. If the money was placed in an interest-earning savings account that paid 10% compounded monthly, the account will earn interest at a rate of 0.833% each month (10% divided by 12 months; 10/12 = 0.833). Over the course of the year, this account will earn $1,047.13 in interest, at an effective annual interest rate of 10.47%, which is notably higher than the returns on the 10% stated annual interest rate of the certificate of deposit.

Stated Annual Interest Rate and Compound Interest

Compound Interest is one of the fundamental principles of finance. The concept is said to have originated in 17th-century Italy. Often described as “interest on interest,” compound interest makes a sum grow at a faster rate than simple interest or going with a stated annual rate – as this is only calculated on the principal amount as stated above.

The exact formula for calculating compound interest is:

Compound Interest = Total amount of Principal and Interest in future (or Future Value) less Principal amount at present (or Present Value)

                        = [P (1 + i) n] – P

                        = P [(1 + i) n – 1]

(Where P = Principal, i = nominal annual interest rate in percentage terms, and n = number of compounding periods.)

Excel is a common tool for calculating compound interest. One method is to multiply each year's new balance by the interest rate. For example, suppose you deposit $1,000 into a savings account with a 4% interest rate that compounds annually and you want to calculate the balance in five years.

On Microsoft Excel, enter "Year" into cell A1 and "Balance" into cell B1. Enter years 0 to 5 into cells A2 through A7. The balance for year 0 is $1,000, so you would enter "1000" into cell B2. Next, enter "=B2*1.05" into cell B3. Then enter "=B3*1.05" into cell B4 and continue to do this until you get to cell B7. In cell B7, the calculation is "=B6*1.05."

Finally, the calculated value in cell B7, $1,216.65, is the balance in your savings account after five years. To find the compound interest value, subtract $1,000 from $1,216.65; this gives you a value of $216.65.

RELATED TERMS
  1. Effective Annual Interest Rate

    The effective annual interest rate is an investment's annual ...
  2. Periodic Interest Rate

    The periodic interest rate is the interest rate charged on a ...
  3. Compounding

    Compounding is the process in which an asset's earnings, from ...
  4. Future Value - FV

    Future value (FV) is the value of a current asset at a date to ...
  5. Automatic Reinvestment Plan

    An automatic reinvestment plan is a mutual fund plan that automatically ...
  6. Compound Probability

    Compound probability is a mathematical term relating to the likeliness ...
Related Articles
  1. Investing

    How to calculate your investment return

    How much are your investments actually returning? The method of calculation can make a significant difference in your true rate of return.
  2. Retirement

    Using Compounding to Boost Retirement Savings

    Allowing growth on your investments to compound over time gives you immense returns when saving for retirement.
  3. Investing

    Investing $100 a month in stocks for 30 years

    Find out how you could potentially earn hundreds of thousands of dollars just by investing $100 a month in stocks during your working years.
  4. 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) balance grow to a significant sum over 20 years.
  5. Personal Finance

    Handling High-Yield Savings Accounts

    Is a high-yield savings account right for you? Read on to find out what they have to offer.
  6. Personal Finance

    5 Financial Math Skills Every Teen Should Learn

    Calculus is good for abstract thinking, but what math skills should every student learn for managing his or her money?
  7. Trading

    Improve your investing with Excel

    Find out how to use Excel, a useful tool for assisting with investment organizations and evaluations.
  8. Managing Wealth

    Retirement: Saving First Million Is the Hardest

    Once retirement savings reach $1 million, building wealth becomes much easier. Here's why.
RELATED FAQS
  1. What formula calculates interest on interest?

    Find out about compounding interest, what it measures, and how to calculate the amount of compound interest accrued using ... Read Answer >>
  2. How do I calculate compound interest using Excel?

    Learn how to calculate compound interest using three different techniques in Microsoft Excel. Read Answer >>
  3. Simple versus compound interest

    Different methods in interest calculation can end up different interest payment. Learn the differences between simple and ... Read Answer >>
  4. How do I calculate how long it takes an investment to double (AKA 'The Rule of 72') ...

    Find out more about the rule of 72, what the rule of 72 measures and how to calculate the rule of 72 for investments using ... Read Answer >>
Trading Center