Every so often someone asks me whether they should switch banks because the other one compounds daily instead of monthly. It sounds like it should matter. Interest on interest, more often, has to be better, right? Technically yes. Practically, the difference is so small you'd struggle to buy a coffee with it.
What compounding frequency means
When a bank quotes a nominal rate, say 7%, the compounding frequency tells you how often the interest gets added to your balance. Monthly compounding means the bank credits a twelfth of that rate each month, and next month's interest is earned on the slightly bigger balance. Daily compounding does the same thing 365 times a year instead of 12.
More frequent compounding does give you a higher effective yield. That part of the marketing is true. The question is how much higher.
The actual numbers
Take 7% nominal. Compounded monthly, the effective annual yield works out to about 7.23%. Compounded daily, it's about 7.25%. That's the whole difference. Going from twelve compounding events a year to three hundred and sixty five buys you roughly 0.02% a year.
On $10,000, 0.02% is about $2 a year. I'm not saying no to $2, but I'm not switching banks for it either, and I'm definitely not treating it as a selling point.
The reason the gap is so small is that each step up in frequency buys less than the one before. Going from annual to monthly compounding captures most of the benefit. Monthly to daily captures a sliver of what's left. Even compounding continuously, every instant of every day, would sit only fractionally above the daily figure. The curve flattens out fast, and by the time you reach daily you're arguing over crumbs.
You can check this yourself with our compound interest calculator. Punch in the same rate and switch the frequency between monthly and daily. Watch how little the final balance changes. Then change the rate by half a percent and watch how much it changes. That comparison tells you everything.
What actually matters
Two things dominate the result, and frequency isn't one of them.
The first is the rate itself. A 7.5% account compounded annually beats a 7% account compounded daily, every time. If you're comparing accounts, compare the APY, which already bakes the compounding in, and pick the higher one. Done.
The second is time. Here's a lump sum example. $10,000 at 7% compounded monthly, left alone for 20 years, grows to $40,387.39. That's the original money quadrupling, and almost none of the credit goes to the choice of monthly over quarterly or daily. The credit goes to the 7% and the 20 years. Compounding frequency is a rounding error sitting on top of those two.
If someone offers you a choice between an account that compounds more often and an account you'll actually leave money in for longer, take the second one without thinking.
Why banks push it anyway
Banks advertise daily compounding because it sounds better than it is. "Your money earns interest every single day" is a nice line. It costs the bank almost nothing to offer, since we've just seen the difference is a couple of basis points, and it gives the marketing team something to say that isn't the rate.
That's the tell, honestly. When an ad leads with compounding frequency rather than the APY, I read it as a sign the APY isn't the strongest in the market. If the rate were great, the rate would be the headline.
Where frequency does show up
One place it's worth a glance is fixed term products. CDs quote an APY, and by law that number already includes whatever compounding the bank does, so two CDs with the same APY pay the same regardless of how the interest is credited internally. Our CD calculator works from the APY for exactly that reason. Compare terms and rates there and ignore the compounding schedule entirely.
The other place is debt, where compounding works against you. The same logic applies in reverse though. The rate on the debt matters enormously. Whether it compounds daily or monthly matters very little.
My take
Compounding itself is powerful. Compounding frequency is a footnote. Chase the best rate, get the money invested early, leave it alone for as long as you can, and let the bank compound it however it likes. If a decision comes down to daily versus monthly compounding, you're choosing between two products that are effectively identical, so pick on fees, access, or whatever else you care about instead.