FD Interest Rate and its functions

Fixed deposits are by far the most popular investment vehicle prevalent in India. From long term investors to new investors, housewives and senior citizens just about everyone have allocated some part of their investment towards a fixed deposit account. The comfort of a safe investment with assured returns along with better interest rates compared to saving bank accounts make fixed deposits a popular choice. The interest rates of fixed deposits have been deregulated by the Reserve Bank of India giving banks the complete freedom to banks to fix interest rates as per their choice.

Banks generally follow the quarterly repo rate announcements from the Reserve Bank of India to tweak their interest rates for fixed deposits, loans and other financial instruments. As long as the interest rates offered by banks for fixed deposits are higher than the annual rate of inflation, people register a growth of their principal amount.

Interest Rates for Fixed Deposits:

Banks interest rates have had a roller coaster ride and have fluctuated randomly over a period of time. Bank fixed deposits have varied from as high as 12% in the early 1990's to 4-5% in 2003s of now bank fixed deposits interest rates fluctuate between 8-9% per annum. Interest rates are calculated either as simple interest or as compounded interest depending on the tenure of the deposit. Most banks calculate interest as a simple interest for fixed deposits for small tenure of up to a period of six months. For longer tenure fixed deposit account, the interest rate is calculated as compounded interest rate which is compounded either half yearly or quarterly depending on the bank concerned.

Fixed Deposit Compounded Interest Rates:

For all fixed deposit accounts that come with an interest rate compounded half yearly, the interest earned on the deposit is reinvested half yearly in case of a one-year fixed deposit. For example if an investor has deposited Rs.3 lakh in a fixed deposit account for tenure of one year at an interest rate of 8% per annum, the user earns an interest of Rs 6000 every quarter.

Fixed deposit account holders can choose between half yearly, quarterly and even monthly compounded interest rates.

FD Interest Rates and Effective Returns:

Fixed deposit returns depend largely on the way interest rate is being applied and calculated. A lot of first time fixed deposit account holders focus only on the interest rate per annum but do not press on the reinvestment time or time period when the interest is calculated. Investing Rs. 1000 at 8% interest rate per annum can earn Rs 20 interest in the first quarter which gets reinvested. The money which is reinvested (Rs. 20 in this case) continues to earn additional interest in the remaining three quarters making it a lucrative affair. Due to the power of compounded interest rates, the investor gets a final interest rate of 8.24% compared to the 8% per annum.