The Differences Between Interest Rates And Yield On Fixed Deposits

By Author: Aman Khanna
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Most people prefer a Fixed Deposit to park their savings in, as it earns interest. Fixed Deposits are secure and, when invested during a high interest regime, of`fer good returns.

Fixed Deposits or term deposits is where a specified sum of money is invested for a defined tenure.

You can open a fixed term deposit account with any bank, financial institution, or NBFC. Infact, deposits with financial companies are equally popular investment options as they come with higher interest rates.

What influences your decision to hold a Fixed Deposit with any bank or financial institution or company? The rate of interest. Higher interest rate on Fixed Deposit offered would be the obvious choice to park your savings.

When you research Fixed Deposits, two terms always pop up—interest rate and yield. But when it comes down to your FD, which factor should your focus on? Read on to find out the differences between interest ...
... rates and yield on Fixed Deposits and then decide which of the two you need to factor in before investing in a Fixed Deposit.

FD Interest

The amount that you invest in a Fixed Deposit earns you interest. This interest rate varies according to various banks and NBFCs. Further, the rates also vary with respect to the tenure. FD interest is the rate at which you earn a return on the principal sum. This gets compounded and what you get at maturity is the principal plus interest.

There are two different ways in which interest payment is disbursed. Under monthly interest payouts, it’s a straightforward calculation, the principal sum x rate of interest. If you opt for a cumulative deposit, in such a case, the interest is compounded, you earn interest on interest.

Infact, most banks advertise the interest rates under various schemes to attract Fixed Deposit investors.

Yield on FD

While the interest rate is explicitly known, determining the yield involves some important calculations. To calculate the yield on a Fixed Deposit, in addition to the compound interest, tax benefits are also taken into consideration.

Interest on Fixed Deposits is exempt from TDS, provided it does not cross the threshold limit in any financial year (Rs.10,000 in the current financial year). If you choose to invest in a 5-year tax saving Fixed Deposit, you can avail deductions of up to Rs.1.5 lakh under section 80C of the Income Tax Act.

While calculating the yield from a Fixed Deposit, these benefits are also adjusted and the total interest earned is divided by the number of years invested, to arrive at the annualized yield.

Always, the yield is more than the interest rate, but cannot be taken as the conclusive factor to determine with whom to invest your Fixed Deposit. Most company deposits lay emphasis on the yield in order to make them more attractive to depositors.

Comparison and examples for FD yields and interests on Fixed Deposit
Let’s explain the difference between yield and interest with a simple example. You deposit an amount of Rs.1 lakh on a 5 year FD which offers 10% interest every year.

The bank will add the interest every year to your principal amount, which will increase your yield for the corresponding year. From the second year onwards you will get the interest on the new principal amount plus the new yield you received along with the previous interest. Remember, with Fixed Deposits, yields are always higher than the interest rates.

At the end of one year, you will get an interest of Rs.1.10 lakh
After the second year the total principal will go up to Rs.1.21 lakh
When the third year hits, the principal will increase to Rs.1.33 lakh
Here’s what this example tells us about yield and interest.

Yield

The yield from an FD is basically the returns you get after taking into consideration all the factors, such as the available tax advantages. For the example we took, the interest rate is 10% and the yield on the FD is Rs.10,000.

Interest

The interest rate is the returns offered on the principal amount based on the compounded interests. Remember to keep in mind that these rates vary from bank to bank, so it is vital you do your research when choosing your bank or NBFC.

How is a overall yield calculated on an FD?

In order for you to find out the yield on your Fixed Deposit, the total returns earned on the investment should be divided by the number of months you had agreed upon.

So, basically, the overall yield you will earn on an FD with a tenure of 5 years would be Rs.61,051 and the interest earned would be Rs.14, 641.
When faced with a dilemma over interest rate or yield, it is prudent that you look to hold a Fixed Deposit that offers the best returns at the end of the tenure. In the end, it all boils down to your requirements and your financial planning.