The time value of money
If lending (and borrowing) money has the timing of interest payments and return of capital in a significant effect on interest rates. For the interest received, it is called the AER (annual equivalent). In the case of interest payments, such as a mortgage, it is called the APR (annual rate) but is effectively the same.
If the VAT on fuel was introduced in 1994, many people paid in advance in order to save the 8% tax. Decisions like these must take into account the effective yield on investments for the period.
For example, your annual fuel cost is £ 100 which is the effective rate of return?
At first glance, one might say, 8%, because what you have saved.
But considering the time value of money, you have to remember that you usually pay a monthly or quarterly. Have paid so ignore seasonal variations, you would only 7 1 / 2 months in advance, on average.
Thus, the effect of the AER (annual equivalent) of 8% 7 1 / 2 months 13%.
Considering that it is effectively a profit after tax was by far the best investment in 1994.
The effect of compound interest
Compound interest occurs when the interest is left in an investment, then there is interest earnings. For example, doubling your money in this investment is:
10 years at an interest rate of 5%
7 years to 10%
only five years by 15%
Another example comes from pensions. To receive a pension of £ 10,000 per year from the age of 65, needs a man to help:
Aged 30 and over £ 150 per month
from 40, £ 300 per month
From 50, £ 600 per month
(For a woman it is 10% more in each case.)
The impact of inflation
“Real” interest rates are the rates of inflation. Only the prices correspond to preserve the real value of capital. Normally they are in the region of 3%, regardless of the actual speed.
However, since all interest is taxable, the high interest rates lead to negative real interest rates, they are not necessarily a good thing for the taxpayers.