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WHAT IS THE AER?

The AER or Annual Equivalent Rate is the official rate for investment accounts, and is designed to allow easy comparisons as it's meant to smooth out the variances between accounts (it's the equivalent of the APR for debts).

The idea is it shows what you'd get over a year if you put money in the account and left it there. The alternative is the gross rate, which is the flat rate of interest that's actually paid.

Frankly this next bit is about to get seriously complicated, so unless you're finding it all crystal clear so far, I'd skip it. If you don't read on, just remember the real lesson is ‘always compare like with like, thus AER with AER or gross with gross.'

Both these rates are usually quoted before tax, but there are two main areas where the difference shows:

Monthly or yearly interest?

If interest is paid annually then the gross rate and AER should be the same, as there's no interest compounding.

Yet when interest is paid monthly, then the gross rate given is usually around 0.1% less than the AER rate. This is because if the monthly interest was left in the account, then there would be interest on the interest too. The AER makes sure this is included.

For an identical account, if interest was paid monthly it would be a 4.89% gross rate, but if interest was paid annually it would be 5% gross. Leave the money there over a year, though, and both would receive the same amount, as the AER for both is 5%.