Two accounts advertise 6 %. One credits interest once a year, the other every month. They do not pay the same. This guide puts a number on the difference, shows why that number is smaller than most people guess, and explains the one situation where compounding frequency genuinely changes a decision.
What compounding frequency actually means
Compounding frequency is how often earned interest is added to your balance and starts earning interest itself. Until it is credited, it does nothing. An account paying 6 % once a year holds your 6 % back for twelve months; an account paying 0.5 % twelve times a year lets the January interest earn for eleven more months.
The rate quoted on the product is almost always the nominal annual rate. The nominal rate is divided by the number of periods to get the rate per period, which is why 6 % nominal credited monthly means 0.5 % per month — not 6 % per month, and not 6 % plus something.
The same 6 %, four different ways
Take 10,000 €, a twenty-year horizon and a nominal rate of 6 %. Change nothing but how often interest is credited.
Monthly beats annual by 1,031 € over twenty years — about 3.2 % more final balance. It is real money and it is free, so take it when it is offered. But it is not the lever most people assume it is: one additional year at 6 % would have added roughly 1,900 €, nearly twice as much.
Why the gap stops growing
Halving the period does not halve the remaining advantage forever. Each step buys less than the one before: annual to half-yearly is worth 549 €, half-yearly to quarterly only 286 €, quarterly to monthly 196 €. The sequence converges.
A = P × e^(r·t)
- The limit as n grows without bound — continuous compounding
- e — Euler's number, roughly 2.71828
- For 10,000 € at 6 % over twenty years: 33,201 €
- That is only 99 € more than monthly compounding
Continuous compounding is the theoretical ceiling, and monthly compounding already captures 99.7 % of it. This is why no bank markets daily compounding as a headline feature: there is almost nothing left to win. It also means you can treat monthly as "good enough" and stop optimising.
Nominal rate, effective rate, and which one to compare
The effective annual rate answers the question "what single annual rate, credited once, would give the same result?" It is the only number that lets you compare two products with different crediting schedules.
effective = (1 + r/n)^n − 1
- r — nominal annual rate as a decimal
- n — crediting events per year
- 6 % nominal, monthly: (1 + 0.06/12)^12 − 1 = 6.168 %
- If two offers quote the same nominal rate, the one crediting more often wins.
- If they quote effective rates, compare them directly — the frequency is already inside the number.
- If one quotes nominal and the other effective, convert before comparing. This is where mis-selling hides.
In the EU an annual percentage rate is mandatory only for consumer credit. For deposits the figure is voluntary and its label varies. Check what the number is called before assuming the two documents on your desk mean the same thing.
What really happens with regular contributions
For a single lump sum, frequency is a rounding difference. Once you pay in regularly a second question appears: from when does a fresh contribution earn interest? In this calculator the interest interval sets the sub-periods of each year, and contributions are spread across those sub-periods. With monthly compounding each monthly instalment is booked in its own month; with annual compounding the twelve instalments of a year count as paid in at the start of the year and earn a full year of interest — a slightly optimistic simplification.
The result surprises most people: 300 € a month for twenty-five years at 6 % yields 118,938 € of interest compounded monthly and 119,363 € compounded annually. The gap is under half a percent, and in the model it even favours annual compounding, because the instalments count earlier there. On a real account the bank's value-dating rule decides from which day a deposit earns interest — and that rule weighs more than the frequency.
What to check on an actual product
- Is the quoted rate nominal or effective? If the document does not say, treat it as nominal and convert.
- How often is interest credited, and is it credited or merely calculated? Some accounts calculate daily but credit annually — that is annual compounding.
- Is the rate fixed or variable? A variable 6 % compounded monthly is worth less than a fixed 5.9 % compounded annually if the rate can be cut next quarter.
- What are the fees, and how are they charged? An annual fee of 0.5 % removes far more than the entire compounding-frequency advantage.
- What is the tax treatment of credited interest? Interest taxed on crediting compounds on the after-tax amount, which lowers the effective rate.
Ranked by how much they move the outcome, fees and taxes come first, the rate second, the horizon third, and compounding frequency a distant fourth. Understanding frequency is worth it so nobody can use it to make a weaker product look stronger — not because optimising it will change your plan.
Keep reading
What each part of A = P × (1 + r/n)^(n·t) does to the result, how to solve it for rate or time, and where a single formula stops being enough.
Four withdrawal rates on the same portfolio, where the 4 % rule comes from, and why the order of the years matters once you are taking money out.
The exact way to turn a nominal return into a real one, what 2 % inflation costs over thirty years, and how to keep a whole plan in today's money.
Divide 72 by the interest rate and you have the doubling time. How accurate that is, where the 72 comes from, and the version worth carrying around.