Compounding Frequency

Compounding frequency is how often interest is added to the principal. Whether it compounds annually, monthly or daily changes what you actually receive.

At the same 5% a year, shorter intervals favour you. Annual compounding turns 1,000 into 1,050 after a year, while monthly compounding gives about 1,051.16, because interest earns interest more often.

The gap grows with time and with the rate. It is negligible on a short deposit, but becomes significant on money compounding over decades.

For borrowing the direction reverses: shorter intervals mean paying more interest. Products calculated daily, such as card cash advances, accumulate cost quickly.

When comparing products, look past the quoted rate to the effective annual rate. Because it incorporates compounding frequency, it puts differently structured products on the same basis. The quickest way to feel the difference is running the same amount through a calculator while changing only the frequency.