Here is how to calculate effective interest rate for fixed deposit;
When you place money in a fixed deposit (FD), banks often quote a nominal interest rate (e.g. 7% per annum).
But the effective interest rate (also called effective yield or effective annual rate) shows the real return you get factoring in how often interest is compounded (quarterly, monthly, etc.).
Because interest earned is periodically added back to the principal, you end up earning “interest on interest,” so your effective yield is higher than the nominal rate.
Hence, effective interest gives a more accurate basis to compare different FDs or investments that have different compounding frequencies.
If your FD compounds interest n times per year (n = 12 for monthly, 4 for quarterly, 1 for annually), and the nominal annual rate is i (in decimal, e.g. 0.07 for 7%), then: Effective Rate (per year) = (1 + i/n)^n – 1
That formula gives you the real annual return you earn after compounding. If compounding is once per year (n = 1), effective = nominal. If more frequent, effective yield > nominal.
Suppose you deposit Rs 100,000 at a nominal rate of 8% p.a., compounding quarterly (n = 4).
i = 8% = 0.08
n = 4
Then: Effective rate = (1 + 0.08 / 4)⁴ – 1
= (1 + 0.02)⁴ – 1
≈ (1.02)⁴ – 1
≈ 1.08243 – 1 = 0.08243, i.e. 8.243% per annum
So even though the advertised rate is 8%, because of quarterly compounding, you effectively earn ~ 8.243% annually.
If the bank applies simple interest (rare for long-term FDs), effective yield equals nominal rate. If interest is compounded, then compounding frequency (monthly, quarterly, annually) affects yield more frequently compounding yields more return.
Always check how interest is credited (compounding frequency) when comparing FDs. Two FDs with the same nominal rate may give different effective yields.
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How to Calculate Effective Interest Rate for Fixed Deposit?
ruchi
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27 days
2025-11-28T16:40:28+00:00 2025-11-28T16:40:30+00:00Comment
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