Most of us look at the interest rate offered by banks or companies and choose the tenor to go with. We do not realize that often times the interest rate shown is not the exact percentage an investor earns on a fixed deposit. The interest rate shown is the “nominal interest rate” or the basic rate without considering the effects of compounding. Banks in India use quarterly compounding to calculate interest rates. Let us see how it is calculated exactly.
Factors Affecting Interest
Tenor: The fixed deposit is a term deposit – where the duration of investment or the tenor makes a huge difference to the interest earned by you. Many banks and financial institutions have an FD interest calculator on their website to show you instantly the interest you will earn at their current rates of interest. The tenors available are from 7 days to 10 years.
Cumulative And Non-Cumulative Option: Another factor that affects the interest payout is the type of investment you have chosen. A cumulative option is one where the interest amount is added to the principal and the interest is calculated annually. This can be used as a money multiplier option. In the case of a non-cumulative option, interest payout frequency is defined by the investor – monthly, quarterly, half-yearly, or annually. The more frequently you withdraw, the lesser interest you will earn.
Choice Of Financier: Fixed deposits are offered by banks and non-banking financial companies (NBFCs). The company fixed deposits offer a high rate of interest as compared to bank fixed deposits.
How Is Fixed Deposit Calculate Interest:
If you were to make a fixed deposit with a high-yielding company fixed deposit, the formula used for interest calculation is as follows –
A = P (1 +( r/4/100)) ^ (4*n)
A = Maturity Amount
P = Deposit Amount or Principal
r = rate of interest
n = Compounded Interest Frequency
Example: If you invest Rs. 1,00,000 in a special fixed deposit with for a period of 3 years, you will earn 8.75% interest (as per the current interest rates being offered). If you go for the cumulative option, the entire interest of the first year is added to the second-year calculation, and so on.
= 100000(1+(8.75%/4))^(43)
= 100000*(1.021875)^12
= 100000*1.29650
=Rs. 1,29,650.23
Thus you will earn an interest of Rs. 1,29,650 – Rs. 1,00,000 = Rs. 29,650 for a period of 3 years.
Effective Annualized Yield:
The “effective annualized yield” will be different when compared to the stated annual interest rate. 8.75% is the stated annual interest rate. But if you choose the compounding option which is done 4 times in the case of Bajaj Finance FD, the final effective annualized yield will be a little more than 8.75%. This can be calculated by the below formula:
Effective Annual Yield = ((1+ r/n) ^n )- 1.
In the above example, ((1+ 8.75%/4) ^4 )- 1 = 9.04%
This is more than the annual interest rate offered. Watch More: Top Forex Signals 2023
Using the FD calculator will give you a fair idea of the percentage earnings you can have when you choose a cumulative as well as a non-cumulative option. You can also adjust the tenor for each of the options.
Getting The Best Fixed Deposit Interest Rate
Keep a lookout for the changes in policy interest rates by the Reserve Bank of India. With an uncertain 2019 with political changes ahead, locking in a high amount of principal at the current FD interest rates will do well to serve your portfolio.
There are people who believe FD rates vary depending on various factors and thus end up with questions like how to calculate FD interest rates. However, the interest rate for a particular FD is fixed as per the investment tenor and can be found easily on the financial institution’s website.
