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What a fixed deposit is

A fixed deposit (FD), called a term deposit or certificate of deposit in some countries, is a bank account where you lock in a lump sum for an agreed period at an agreed interest rate. Because the rate and the period are fixed in advance, you know exactly what you will get on the maturity date, which makes FDs popular for money you cannot afford to risk: an emergency fund, a wedding, school fees or a house deposit.

In return for that certainty you accept two limits. The rate is usually lower than the long-term returns of riskier investments, and you pay a penalty or lose part of the interest if you withdraw before maturity.

How the maturity amount is calculated

For a deposit that adds interest to the balance, the maturity value is P × (1 + r ÷ n)^(n × t). P is the deposit, r is the yearly rate as a decimal, n is how many times a year interest is added and t is the time in years. For 1,00,000 at 7 percent for five years with quarterly compounding, n is 4 and the maturity is 1,41,478, so the interest is 41,478.

For a deposit that pays simple interest at maturity, the formula is P × (1 + r × t). The same 1,00,000 at 7 percent for five years gives 1,35,000, which is 6,478 less than the quarterly compounded deposit. That is why it matters to know which kind you are being offered.

Compounding frequency and effective yield

The more often interest is added, the more you earn, because interest itself starts to earn interest sooner. On 1,00,000 at 7 percent for five years, yearly compounding gives 1,40,255, half-yearly 1,41,060, quarterly 1,41,478 and monthly 1,41,763. The gap between yearly and monthly is about 1,500, which is small but real.

The effective yield expresses this as one comparable number. A 7 percent rate compounded quarterly has an effective yield of 7.19 percent, and compounded monthly 7.23 percent. When two banks quote similar rates, compare their effective yields, not their headline rates.

Comparing offers properly

Interest rate tables can hide differences that matter. Before you choose a deposit, compare the following.

• The effective yield, so that different compounding schedules are comparable.
• The tenure. A slightly higher rate for a much longer lock-in may not be worth it.
• Whether interest is paid out periodically or added to the deposit. Payout deposits do not compound.
• The penalty for early withdrawal and whether partial withdrawals are allowed.
• Deposit insurance limits in your country, and the strength of the bank.
• Tax on the interest, since a lower taxed rate can beat a higher one after tax.

An FD or something else?

A fixed deposit is right when you know when you will need the money and cannot accept losses. It is not designed to beat inflation over long periods, and a deposit that pays less than inflation loses buying power even while its balance grows. Use the Inflation Calculator to compare the interest you earn with the price rise. For longer goals where you can accept ups and downs, regular investing with the SIP Calculator or a growing balance with the Compound Interest Calculator may fit better.

To see the growth rate of what you actually earned, use the CAGR Calculator, and to compare with plain interest use the Simple Interest Calculator. The calculation runs in your browser and nothing is stored. Banks may compute interest a little differently, so treat the result as an estimate and rely on the deposit certificate for the final figure.