Effective annual rate is the rate of interest taken into account compounding over the year. For example, a bank offers 2 percent interest each month. The bank account is making over 2 percent over the course of a year due to compounding. By finding the effective annual rate of more than one investment, an investor may apply his money to the investment with the highest return.

Step 1

Divide the annual interest rate by the number of periods compounding, then add one to the answer. In the example, 2 percent divided by 12 months, equals 0.001667, plus 1, which equals 1.001667.

Step 2

Raise the number calculated in Step 1 to the power of the number of periods compounding. In the example, 1.001667 ^ 12, which equals 1.020814.

Step 3

Subtract 1 from the number calculated in Step 2. In the example, 1 minus 1.020814 equals 0.020814.

Step 4

Multiply the number calculated in Step 3 by 100 percent. In the example, 0.020814 times 100 percent equals an effective annual rate of 2.0814 percent.