When investing funds in a security, you expect a profit in return. Certain types of investments, such as bonds and mutual funds, earn profits through interest. Depending on the terms of the investment, you may receive interest payments periodically, or you can receive all of your interest in a lump sum when the investment matures.
The amount of interest you receive is based on an annual interest rate, which is the percentage of your investment that you earn each year. You can earn all of your annual interest at one time during the year, or earn a fraction of your total interest daily, monthly or quarterly.
Regular Interest vs. Accrued Interest
Investments that include regular interest pay a certain amount of interest periodically according to an established schedule. For example, a bond can pay an investor 3 percent interest each year until the bond matures. Investments that pay accrued interest, however, pay the investor all of the interest earned over the life of the investment when it matures. Such investments typically compound their interest, or add it to the principal, until they reach maturity.
While investments featuring regular interest pay the investor more frequently, an investment featuring accrued interest provides a greater profit in the end. As the interest compounds, the value of the principal increases. The more often the interest compounds, the more total profit you earn on the investment at maturity.
Assume an investor purchases a $10,000 bond with a term of three years and an annual interest rate of 2 percent. If the bond features regular interest, the investor will receive $200 profit each year until the bond matures. The total profit will be $600 [3 x (10,000 x .02)]. However, if the bond pays accrued interest, the investor will receive a total profit of $612.08 [(10,000 x .02) + (10,200 x .02) + (10,404 x .02)].