Fixed deposits (FDs) are a secure investment option offering assured returns to investors. However, interest earnings can vary widely depending on the calculation methods used. Understanding how FD returns are computed enables selecting the right FD offerings and maximising investment income.
This article explains the concept of FD interest rates, factors impacting rates, and tips for choosing suitable FDs aligning with investment objectives.
What is a Fixed Deposit?
A fixed deposit refers to a financial instrument offered by banks that provides interest rates higher than savings accounts. Investors can deposit a lump sum amount with the bank for a defined tenure ranging from 7 days to 10 years.
The money remains locked in for the entire period. Banks offer guaranteed returns in the form of interest rates, which remain fixed and consistent for the period, irrespective of market rate movements. This inherent nature of assured returns against investments is what defines the actual FD meaning for investors with low or moderate risk appetites.
FDs carry zero risk as returns are known upfront. Deposit amounts and earned interest are safe and paid back by the bank as per contractual maturity. Compared to stocks or mutual funds, Fixed version: Fixed deposits (FDs) by IDFC FIRST Bank offer lower returns compared to other investment options, but they provide a guaranteed return on investment.
Types of Fixed Deposit Interest Rates
FDs calculate interest using either simple or compounding methods:
1. Simple Interest FDs:
FD interest is computed only on the original principal amount for the specific deposit period. The interest amount is calculated by:
Interest = Principal x Interest Rate x Tenure
For instance, if ₹1 lakh is deposited for 1 year at 6% simple interest offered, interest earnings will be:
1,00,000 X 6% X 1 year = ₹6,000
2. Compound Interest FDs:
Under this mechanism, the fixed deposit interest at IDFC FIRST Bank keeps accruing on cumulative deposits comprising both Principal and interest earned in the previous compounding cycle.
The formula is:
A = P(1 + r/n)^(nt)
Here,
A = Maturity Value
P = Principal Amount
r = Annual Interest Rate
n = Number of compounding periods per year
t = Number of years
Factors Influencing Interest Rates
While banks determine FD rates basis RBI’s monetary policies, the below factors also impact rates offered to investors:
- Economic conditions: In a high inflationary environment, rates tend to be higher.
- Tenure: Longer maturity terms for FDs attract higher interest rates.
- Deposit size: Bulk deposits above ₹1 crore may get preferential rates.
- Age: Banks, including IDFC FIRST Bank, may offer higher rates to senior citizens.
- Bank’s liquidity needs: Banks with higher credit growth offer competitive interest rates on FDs to raise funds.
Choosing the Right FD
Before investing in bank fixed deposits (FDs), it is important to consider the following tips:
- Compare compound vs. simple interest projections across banks to identify higher returns.
- Evaluate applicable taxes on interest earnings and post-tax returns.
- Consider laddering FDs across shorter and longer tenures for liquidity and yield balance.
- Review all terms – minimum amounts, premature withdrawal policy, and interest payout options before fixing deposit size and tenure.
Conclusion
Rates of interest applicable on fixed deposits vary depending on the calculation methodology opted for and the tenor selected, amongst other factors. Investors must assess simple vs. compounding techniques and evaluate applicable taxes and liquidity needs before distributing surplus amounts across FDs of varied maturities. Ultimately, the ability to size up options and make informed decisions leads to optimal returns.
