Comparing deposit rates properly
Two deposits with different rates and different compounding frequencies cannot be compared by their headline numbers. Converting each one to an effective annual yield, or simply to a maturity amount on the same principal and tenure, is the only reliable comparison.
Formula
Compare on effective yield: (1 + r/n)^n − 1
- A lower nominal rate compounded more often can beat a higher annual rate
- For the same tenure and principal, the higher maturity amount always wins
- Post-tax comparison: multiply the yield by (1 − your marginal tax rate)
When the lower rate wins
A 7.4% deposit compounded quarterly has an effective yield of about 7.61%, which beats a 7.5% deposit compounded annually. The headline comparison points the wrong way.
This is a common situation between banks and NBFC deposits, and between cumulative and payout options at the same institution. Always convert before choosing.
Rate is not the only variable
A small rate advantage can be outweighed by other terms: the premature withdrawal penalty, whether a loan against the deposit is available, the minimum tenure, and how easily the deposit can be split.
Institutional safety matters more than a quarter of a percent. Bank deposits carry DICGC cover up to ₹5 lakh per depositor per bank; corporate and NBFC deposits carry no such cover and should be judged on credit rating.
Compare after tax, not before
Deposit interest is taxed at your slab rate, so a 7.5% deposit returns about 5.2% after tax in the 30% bracket. That figure is what you should compare against a tax-free instrument or a debt fund.
For a senior citizen with limited other income, the same deposit may effectively be tax-free within the deduction available on interest income — which can change the ranking entirely.
Laddering beats chasing the top rate
Splitting money across several tenures means part of it matures regularly and can be reinvested at whatever rates prevail then. This removes the need to guess where rates are heading.
It also limits the damage from breaking a deposit early, since you only break the tranche you need rather than the whole amount.
Which deposit is better?
- Option A
- 7.50% compounded annually
- Option A effective yield
- 7.50%
- Option B
- 7.40% compounded quarterly
- Option B effective yield
- ≈ 7.61%
- Winner before tax
- Option B
- Option B after 30% tax
- ≈ 5.24%
The deposit with the lower advertised rate pays more. Once tax is applied, both fall well below inflation-beating territory, which is the more important conclusion.