How is Yield Different from Interest Rate on Fixed Deposits?

Fixed deposits (FD) are a good investment option for those who don’t want to risk putting their money in the market. They offer good returns on your investment, without the fear of losing your money.

The assured returns also make them a great choice to create a corpus for emergencies. Moreover, they offer flexible tenors between 12 to 60 months and many benefits for senior citizens, adding to their appeal as an investment.

How is Yield Different from Interest Rate on Fixed Deposits?

Why should you know the difference between Yield and Interest Rates?

Both banks and non-banking financial corporations (NBFCs) offer FDs to their customers. To make the offering more attractive, these organizations usually highlight the annual effective yield on their FDs, more than the FD interest rate, while advertising them.

The FD interest rates are however, shown towards the end of the advertisement. The problem is that most investors don’t know the difference between the two and are left feeling confused.

Smart advertising can easily cloak the differences between yield and interest rates, which makes it more important to be cognizant of the differences between the two. Let’s look at them one by one:

FD interest rate

The FD interest rate is the return offered on the principal amount that is calculated based purely on compound interest, without including any other factors. You can use an FD calculator to find out the total interest you will get for your FD. For example, the Bajaj Finance FD offers an FD interest rate of up to 8.40% on your investment, with flexible tenors between 1 to 5 years. So, if you invest Rs. 25,000 at 8.40% for three years, the interest you earn at the end of three years will be Rs. 6,844. At maturity you will get Rs. 31,844. The FD interest rate remains constant throughout the tenor of the FD.

Effective annual yield

The annual yield on the other hand, includes the compound interest and other factors like the tax benefits till the end of the tenor. The calculation here works in reverse. To know the effective annual yield, you need to divide the total return earned on investment by the number of years the money was invested for.

So, in the above Bajaj Finance FD example, you would need to divide the total interest earned which was Rs. 6,844 by the number of years the money was invested for, which was 3 years. That gives you an annual yield of Rs. 2,281, which makes the percentage yield or annualized effective yield at the end of three years 22.81%. Remember though that although the interest rate is only 8.65% and the effective yield is 22.81% the total return of Rs. 6,844 doesn’t change.

FD interest rate vs. Effective annual yield

Annual FD interest rate is constant, while the annual yield increases every year for the same interest rate. So, considering the above example once again, we can say that we have a 3-year FD for an annual FD interest rate of 8.40% interest rate, or we can say that we have a 3-year FD with an annualized yield of 22.81%.

Customers would obviously be attracted to the latter. However, both are the same product and the total returns you get don’t change. Thus, you need to consider the annual FD interest rate more carefully than the effective annualized yield.