Annualized yield is a notion associated most often with fixed deposits. Many of us do not realize that it could be used with recurring deposits as well.
It can be, and is used by many banks. FD yield though misleading, is at least correctly calculated.
I am very uncomfortable with the way RD yield is calculated and used by banks. The value advertised seems to correspond only to the first monthly instalment and is therefore naturally high!
To address this issue, I have updated the comprehensive recurring deposit calculator published earlier to include annualised yield information. As you may recall, the recurring deposit calculator helps you calculate tax liability each financial year.
To understand how annualized yield is calculated and how it difference from annual interest you could refer to my previous post: Fixed Deposits: Annual Yield vs. Annual Interest
Here is a brief primer: If I invest Rs. 100 in a FD that gives 10% interest per year, after three years, my investment will be worth, Rs. 133.1.
The annualized yield = (133.1 – 100)/(100 x 3) =11.033%
Thus, the annual yield is defined as the relative difference in investment value per year of investment.
A recurring deposit can be thought of as a monthly FD wherein all instalments mature on the same date.
Therefore, each instalment will have its own interest. The first instalment will give the highest interest as its investment duration corresponds to the duration of the RD.
The last instalment gives the lowest interest, as its investment duration is just a month.
Trouble is, unlike an FD, each instalment of a RD has its own annualised yield value.
The first instalment will have the highest annualised yield and the last instalment, the lowest. Imagine the bars of a Xylophone to get the picture!
So what is the annualised yield of the RD? Since each instalment has its own yield, one could take the average of the yields and denote that as the yield of the RD. Just one of many ways of doing it.
Many banks advertise a yield figure with their recurring deposits. It is disturbing to note that the advertised yield seems to correspond to the first instalment (highest yield) only!
This is not just misleading (as for the FD yields) but plain wrong!
Here is the updated comprehensive recurring deposit calculator with pre-tax and post-tax annualized yields for each RD instalment. The average yields are also computed. You can also calculate tax to be paid each financial year.
If you are confused about when to pay income tax for recurring deposits, you could see the discussion here: Debt Mutual Fund vs. Fixed Deposit Comparator – Version II
Credit: Mr. Srinivas, a banker wanted yield information on FDs and RDs. Both calculators were inspired by his email.