Last Updated on December 31, 2015 at 10:59 pm
Beware! Corporate fixed deposits that offer 8.25% annual return are being marketed by prominently quoting their ten-year annual yield of 12.09%. A look at how this form of mis-selling based on a technicality.
The ad says,
Earn assured returns (first line – font size about half an inch)
upto 12.09* % p. a. (second line – 12.09 is printed about 2 inches long!)
offered by AAA/AA+ raed FD schemes (third line – about normal font)
A table of corporate fd with returns (12.09 is no where to be seen)
(*) XYZ corporate bond offering 12.09% pa yield to maturity for 10Y deposit @ 8.5% p.ap compounding annually
How many would understand that 8.5% is the actual annual return on investment and this 12.09% – the most prominent figure in the ad has no relevance whatsoever to the investor?!
Sure, like all forms of mis-selling, the ad has technically correct information. It is designed with only purpose: the audience must be given the impression that the assured return is 12.09% p.a
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Sure this 12.09% is a measure of return, but it is not the annual return. The annual return is 8.5%.
If you invest Rs. 100, the value after 1 year = 100*(1+8.25%) = 108.3
after 2 years, 100(1+8.25%)(1+8.25%) =117.2
after 3 years, 100(1+8.25%)(1+8.25%)*(1+8.25%) = 126.8 and so on.
The annualized yield is not constant. It will increase with each month of investment.
The annualized yield is equal to total gain made after ‘n’ years, divided by ‘n’ of years invested.
After 1 Y the annual yield = ((1+8.25%)-1)
After 2Y, ((1+8.25%)^2-1)/2 =8.59% (gain made after 2 years)/2
After 3Y, ((1+8.25%)^3-1)/3 = 8.94%
After 10Y, ((1+8.25%)^10-1)/10 =12.09%
Therefore, while the return which presents the rate at which money grows is constant for a fixed deposit, the annualized yield is nothing by the gain made per year and this increases with increase in the tenure of the deposit.
Instead of advertising the return of the deposit as 8.25%, the ad uses the 10-year annualized yield of 12.09%, and makes it sound as if it is a product that gives you assured returns of 12.09%. Beware!
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Use this Fixed Deposits: Annual Yield vs. Annual Interest to understand more about yield and to calculate return from yield and yield from return.
The concept of yied for RD is discussed here: Recurring Deposit Calculator: Annualized Yield