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Let us face it, most investors are confused with the two percentages associated with a fixed deposit: annual interest and annual yield. Most people make the common mistake of assuming that the yield (often higher than the interest rate) is the interest rate!
So let us try to understand what each term represents.
Annual Interest:
If I invest Rs. 100 in a FD that offer 10% per year, my investment will grow to
- Rs. 110 at the end of 1 year
- Rs. 121 at the end of 2 years
- Rs. 133.1 at the end of 3 years.
If I want to represent this growth by a constant percentage, then I use the annual interest rate.
- 100 X (1+10%) = 110 (year 1)
- 100 X (1+10%) X (1+10%) = 121 (year 2)
- 100 X (1+10%) X (1+10%) X (1+10%) = 133.1 (year 3)
Therefore, the constant percentage is the annual interest rate of the FD, 10%
Annual Yield:
Suppose I want to know the relative difference in my investment at the end of each year,
- (110-100)/100 = 10% (year 1)
- (121-100)/100 = 21% (year 2)
- (133.1-100)/100 = 33.1% (year 3)
Although I understand the notion of the relative difference, I hope you agree with me that it does not help much. Obviously, the relative difference of a one-year FD will be more than that of a two year FD. Beyond that, relative difference does not give us an insight in the manner of growth.
Annual yield is defined as the relative difference in investment value per year of investment.
For each year of investment the annual yield is,
- 10%/(1) = 10% (year 1)
- 21%/(2) = 10.5% (year 2)
- 33.1%/(3) = 11.033% (year 3)
Key difference between the annual yield (rate) and annual interest rate:
Annual Interest rate is a constant for a fixed deposit. Annual yield rate increases with the increase in duration for the same interest rate.
For simplicity, I have considered annual compounding. Other types of compounding are available for analysis in the excel tool.
Now, let us say I work in a bank, and my job is to sell FDs, in particular the FD, we have considered above.
Which statement would catch a client’s attention?
A 3-year FD with 10% annual interest
or
‘a 3-year FD with an annualized yield of 11.033%’?
Obviously many people assume that their money will grow at the rate of 11.033%.
This is wrong. Their money will grow at 10% and will produce an annual(ised!) yield of 11.033%.
- Given the yield rate, the interest rate can be calculated.
- Given the interest rate, the yield rate for any duration can be calculated (why bother!)
- Use this excel tool to understand the relationship between yield rate and interest rate for a fixed deposit.
- This calculator was requested by Mr. Srinivas, a banker.
Download the Fixed Deposit Yield vs. Rate Analyzer
Download the Comprehensive fixed deposit calculator
with total and advance tax liability each financial year, now updated with pre-tax and post-tax annual yields for each month of investment.
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M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice.He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com
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Very nice and helpful article. I used to get confused with Annual Yield but it is explained so well in here. Loved the Fixed Deposit Yield vs. Rate Analyzer calculator! Using it cleared my doubts further. 🙂
Thank Ayush 🙂
Very nice and helpful article. I used to get confused with Annual Yield but it is explained so well in here. Loved the Fixed Deposit Yield vs. Rate Analyzer calculator! Using it cleared my doubts further. 🙂
Thank Ayush 🙂
thanks 🙂 This actually clears up my question
thanks 🙂 This actually clears up my question
very nice once again sir.I have doubt(may look silly).I have a FD and will mature this Dec.If i reinvest the same,do i need to pay tax for the interest accumulated till now(i.e end of tenure).Or bank will deduct TDS??
Thanks Dilip.
If you fall in 10% slab then Bank will deduct it as TDS and nothing more to do. For 20% and 30% slabs, remaining 10% 0r 20% has to be calculated and paid as tax. My FD calculator will help you find out the tax liability.
very nice once again sir.I have doubt(may look silly).I have a FD and will mature this Dec.If i reinvest the same,do i need to pay tax for the interest accumulated till now(i.e end of tenure).Or bank will deduct TDS??
Thanks Dilip.
If you fall in 10% slab then Bank will deduct it as TDS and nothing more to do. For 20% and 30% slabs, remaining 10% 0r 20% has to be calculated and paid as tax. My FD calculator will help you find out the tax liability.
Very helpful and necessary post.
Many thanks Sandip.
Very helpful and necessary post.
Many thanks Sandip.
Thanks for the info! This is nicely explained in details in a “SlideShare” presentation (Link given below). A few relevant points need to be mentioned:
(1) A 3-yr FD of 10% SIMPLE interest will have an Annualised Yield of 10% only for any duration.
(2) The 10% COMPOUND Interest makes all the difference, of course in banking & business we come across Simple Interest very rarely.
(3) The results are calculated on the basis of compounding period of one year. If we make it Quarterly, then the figure 11.033% becomes 11.496%.
(4) Annualised Yield is simply the Simple Interest equivalent of a Compound Interest for a particular duration – For the same compound interest the Annualised Yield varies with duration and compounding Interval.
Pls. enjoy the full presentation at: http://www.slideshare.net/hisema/simple-and-compound-interest-24834757, and give me your valuable feedback. Thanks!
=Himansu S M
Thanks for pointing out that the annualised yield is the simple interest for the duration of the investment. Unfortunately, it is cold comfort. The idea of yield is unnecessary for fixed deposits and is misused by banks. The other ideas you discussed are available as variable options in the calculator.
Thanks for the info! This is nicely explained in details in a “SlideShare” presentation (Link given below). A few relevant points need to be mentioned:
(1) A 3-yr FD of 10% SIMPLE interest will have an Annualised Yield of 10% only for any duration.
(2) The 10% COMPOUND Interest makes all the difference, of course in banking & business we come across Simple Interest very rarely.
(3) The results are calculated on the basis of compounding period of one year. If we make it Quarterly, then the figure 11.033% becomes 11.496%.
(4) Annualised Yield is simply the Simple Interest equivalent of a Compound Interest for a particular duration – For the same compound interest the Annualised Yield varies with duration and compounding Interval.
Pls. enjoy the full presentation at: http://www.slideshare.net/hisema/simple-and-compound-interest-24834757, and give me your valuable feedback. Thanks!
=Himansu S M
Thanks for pointing out that the annualised yield is the simple interest for the duration of the investment. Unfortunately, it is cold comfort. The idea of yield is unnecessary for fixed deposits and is misused by banks. The other ideas you discussed are available as variable options in the calculator.
Hi,
We have any flexibility to change the “Day Convention” this calculator. Will be very useful, if this calculator has “Day Convention” filter also to select.
If you want to calculate FD corpus and associated parameters, you could use the days calculator here:
http://freefincal.com/fixed-deposit-calculators/
Hi,
We have any flexibility to change the “Day Convention” this calculator. Will be very useful, if this calculator has “Day Convention” filter also to select.
If you want to calculate FD corpus and associated parameters, you could use the days calculator here:
http://freefincal.com/fixed-deposit-calculators/
Great job, it helped me to clarify my doubts associated with annual yield
Thank you.
Great job, it helped me to clarify my doubts associated with annual yield
Thank you.
I want to knw about diff. Btwn intrest pa and annuallised interest yeild and which is better for fd ?
I want to do fd for 1 year or for 9 months….???
And compound intrestd benefitt now we can take after 1 year or after 9 months …i can get.
1 lacs i invest in canara bank at the rate of 7.75% for 9 months….but i m not satisfied with their reply……if i break this fd and invest again for 1 year then its btr or 9 month is ok???
interest pa is all that counts. Ignore yield.