Compounding frequency is how often earned interest is added to your balance. With the same advertised rate, more frequent compounding means slightly more growth, because interest starts earning interest sooner.
Nominal rate vs effective annual rate
The advertised, or nominal, rate doesn't include compounding. The effective annual rate (EAR) does: EAR = (1 + r/n)n − 1.
| Compounding | Effective annual rate | $10,000 after 10 years |
|---|---|---|
| Annually | 5.000% | $16,289 |
| Semi-annually | 5.063% | $16,386 |
| Quarterly | 5.095% | $16,436 |
| Monthly | 5.116% | $16,470 |
| Daily | 5.127% | $16,487 |
Moving from annual to daily compounding adds about $200 over ten years on $10,000. Real, but much less important than the rate itself, your deposits and time.
Savings accounts and GICs
Many Canadian savings accounts calculate interest daily and pay it monthly. GICs may compound annually or pay simple interest; compare the effective annual yield when choosing.
Canadian mortgages
Fixed-rate mortgages in Canada are compounded semi-annually, not in advance, as required by the federal Interest Act, even though you usually pay monthly. Variable-rate mortgages often compound monthly. That's why a mortgage calculator built for the US can give a slightly different payment.
Frequently asked questions
Is daily compounding much better than monthly?
Only slightly. At 5%, the effective annual rate is 5.127% daily versus 5.116% monthly.
How often do Canadian fixed mortgages compound?
Semi-annually, not in advance.
Sources
- Justice Laws Website, Interest Act