Two accounts advertising the same interest rate can pay different amounts over a year. The difference lies in how often interest is calculated and added to the balance.
Interest that is credited starts earning
When interest is added to an account, it joins the balance and earns interest itself in subsequent periods. Until it is credited, it does not.
An account paying monthly therefore has eleven opportunities during the year for previously earned interest to generate further interest, while an annual account has none.
The nominal rate is unchanged in both cases. What differs is the number of times the balance is refreshed before the rate is applied again.
The effect is real but modest at ordinary rates
The gap between annual and monthly compounding at typical deposit rates is small, amounting to a fraction of a percentage point on the effective return.
It grows with the rate. At very high rates the difference between compounding periods becomes material, which is why the distinction matters far more on borrowing than on saving.
Moving from monthly to daily compounding adds very little further, because the additional periods each contribute progressively less than the one before.
Equivalent annual figures exist to make comparison possible
Because nominal rates are not comparable across different compounding frequencies, providers quote a standardised annual figure that expresses what the account actually returns over a year.
That figure folds the compounding assumption into a single number, allowing an account paying monthly and one paying annually to be compared directly.
It assumes the balance stays untouched for the full period, so it describes the account's mechanics rather than a prediction about any particular saver's outcome.
Monthly interest is not always the better choice
Savers who withdraw interest as income gain nothing from frequent crediting, because the money leaves before it can compound.
For them the choice is about cash flow timing rather than return, and an account paying annually at a marginally higher nominal rate may deliver more.
Where interest is left in place, more frequent crediting is straightforwardly better, holding everything else about the account constant.
The compounding rule matters less than the rate itself
Frequency differences are measured in small fractions of a percent, while the spread between the best and worst accounts available at any moment is far larger.
A saver optimising for compounding frequency while leaving money in an uncompetitive account has attended to the smaller variable.
Frequency is worth checking when two otherwise identical products are being compared, and worth ignoring when the alternative is an account paying a meaningfully different rate.