What does AER mean?
AER stands for Annual Equivalent Rate.
It’s a way of showing the amount of interest you’ll get if you keep your money in a savings account for a year (which is where the ‘annual’ part comes from).
AER explained
All banks and building societies show their interest rate as AER (which is always shown as a percentage).
This makes it easier for you to compare different savings products and work out how much interest you could get in a year (before tax reductions).
The higher the AER, the more interest you can expect to earn.
How does AER work?
AER factors in compound interest – bear with us on this!
Compound interest is essentially the interest you earn on your interest, which then earns more interest, and so on…
How compound interest works
Let’s say you have a savings account that pays interest every month.
Each month interest is added, so your account balance gets bigger (as long as you don’t withdraw more money than the amount of interest added).
So when interest is calculated for the following month on the bigger balance, the amount of interest you’ll earn will be higher too.
AER takes all this compounding into account, as it’s calculated using the interest rate and the number of times interest will be paid throughout the year.
Essentially it does the hard maths for you, making it easier for you to work out how much interest you’ll get in a year.
What is the difference between AER and gross interest?
Gross interest is the annual rate of interest you’ll earn on your savings.
But it doesn’t take compound interest into account like AER does – it doesn’t do the maths for you.
So AER can give you a more realistic idea of how much interest you could earn over time.
How AER can help you compare savings products
Seeing the AER can help you choose the best savings product for you because:
- it helps you compare different savings products (like savings accounts and ISAs) that pay interest differently (monthly, annually etc)
- it gives you a realistic idea of how much interest you could earn over a year (before any tax reductions).
Say one product pays interest monthly, and the other annually. With monthly interest, this will compound every month, whereas there won't be any compounding throughout the year with the annual interest option (as the interest is only paid after a year).
Without knowing the AER for each product, it's more difficult to work out how much interest you could get after a year.
But if they both have an AER of 4%, this means you know you’ll get the same amount of interest. So it makes it easier to compare the two without getting your calculator out.
It’s important to note that although AER gives you a good idea of how much interest you could earn, it doesn’t take into account any account fees or charges you may need to pay.
Interest vs investment returns
Earning interest on your savings isn’t the only way to potentially grow your money.
You can also invest your money, which typically means paying into an investment fund along with other investors' money.
The investment fund aims to make your money grow by buying various different types of investments: things like shares in companies, property and corporate and government bonds.
Your money increases or decreases as the value of those assets changes.
With investing there’s good potential for your money to grow. However there's also a risk of ending up with less money than you've put in. This happens if you withdraw your money at a time when the assets invested in are worth less than they were when you started investing.
This is why it’s recommended that you only invest if you’re planning to keep your money locked away for the long-term. If you’re thinking shorter-term, saving in a cash product might be better for you.
Investing made simple
At OneFamily we think everyone should have the opportunity to invest their money.
Our Lifetime ISA and Stocks and Shares ISA invest in stocks and shares because we believe this gives your money the best chance of out-growing inflation - compared to Cash ISAs, which grow your money with interest rates.
As with all investing, the value can go up and down and you could get back less than you’ve paid in.
*If you don't use your lifetime ISA the way the government intended, you'll have to pay a 25% government withdrawal charge. This could mean you lose some of the money you paid in, as well as the bonus. We explain more about the charge in our withdrawal charge article.
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