Short answer: No, not really, unless you are talking amounts over six figures.
I’ve seen so many people get hung up on this, I think it deserves a post. The easiest way to explain it is with an example. Let’s say ‘DaBank’ compounds interest daily on their accounts, and ‘MoBank’ compounds interest monthly. Let’s say you have a $10,000, 1-Year CD with both of them at the same 5% APR interest rate, and compare how much interest you have at the end of the year. Both credit interest monthly.
Since MoBank compounds monthly, you are getting 5%/12 = .4166% every month. So, at the end of the first month, you will have 10,000 x 1.004166 = $10041.67. During the second month, you will be earning .4166% on $10041.67, not just $10,000. So at the end of the 2nd month you’ll have $10083.51, not $10083.34. This goes on for twelve months:
$10,000 x (1 + .05/12)12 = $10511.62.
Since DaBank compounds daily, you are getting 5%/365 = .0137% every day. So, at the end of the first day, you will have 10,000 x 1.000137 = $10001.37. Using the same basic formula as above for 365 days:
$10,000 x (1 + .05/365)365 = $10,512.67.
So over the course of a year you’ve only earned $1.05 more by compounding daily versus compounding monthly!
The easy way to not even worry about this is to just compare APY instead of APR.
If you compare APYs, or annual percentage yield, the compounding effect is already taken into account, whether it be daily, monthly, or every 6.374 seconds.
In our example above, MoBank would advertise a 5.12% APY and DaBank could advertise a 5.13% APY, with the same 5% APR. I hope that clears things up for some!
By Jonathan Ping | Banking | 9/3/05, 1:12pm