Tuesday, April 10, 2007

Magical Interest Rates

How many times have you seen this number on a billboard at a traffic signal? How many times have you ignored it, just to look at a more interesting advertisement? Today, we are back to this boring number. Fixed Deposits and Compound Interests

Here’s an old story about compound interest

In the early 1600s, the American Indians sold an island, now called Manhattan in New York, for various beads and trinkets worth about $24. Since Manhattan real estate is now some of the most expensive in the world, it would seem at first glance that the American Indians made a terrible deal. Had the American Indians, however, sold their beads and trinkets, invested their $24 and received 9.5% compounded annual interest, not only would they have enough money to buy back all of Manhattan, they would still have several hundred million dollars left over. That is the power of compound interest over time.
Source: Savingadvice.com

Time and Interest Rate – The two most important aspects of compounded interest.

  1. Rs. 100 at 9% interest compounded quarterly would be Rs. 156.05 in 5 years and Rs. 243.52 in 10 years. With simple interest the same amount at 9% would be Rs. 190. If that doesn’t sound too big, let’s calculate this for an amount of Rs. 200,000

Compound interest – 9% for 10 years – Rs. 487,037.79
Simple Interest – 9% for 10 years – Rs. 380,000

  1. Rs. 100 at 7% interest compounded quarterly would be Rs. 200.16 in 10 years. Hence at 7% interest an amount takes 10 years to double. On the other hand, Rs. 100 at 9% interest compounded quarterly would be Rs. 243.52 in 10 years. At this rate an amount takes just 8 years to double!!

Now that we have the basics of compounding, the following will aid you to make a decision on Fixed Deposits

  1. Are you the first time investor in the process of creating an emergency fund or are you putting away a part of your money in risk-free investments before plunging into riskier investments? What is a better time than this and which is a better tool that this?
  2. A Fixed Deposit or a Term Deposit is an investment tool that allows you to set aside some money in the form of a deposit in a bank or a financial institution or a company and fetches you compounded interest (monthly/quarterly/annually) for the period specified.
  3. Currently, the highest interest rates are being offered over a period of 3-5 years (3 years 3 months being most common). In the case of the investor withdrawing the deposit before the completion of the term, most banks impose a fine known as the pre-closure penalty. This could vary from a small penalty of 0.5-1.5% on the interest earned or a lower interest rate would apply for the short term. In some cases the bank does not allow premature closure of the deposit.
  4. Most banks specify a minimum deposit amount that could range from Rs. 100 up to Rs. 25,000. The most common minimum deposit amount is Rs. 10,000.
  5. The links to the Fixed Deposit information of four significant banks are as follows
    1. State Bank of India
    2. State bank of Mysore
    3. HDFC Bank
    4. ICICI Bank

Also worth considering is the attractive Fixed Deposit scheme from Canara Bank

  1. In the case of all the above schemes interest is compounded quarterly. Hence the effective annual rate of interest is higher than the one specified.
  2. For interest payable above a sum of Rs. 10,000 for an assessment year on all fixed deposits in a bank, tax at the rate of 10% is deducted at source. In the event of the investor not liable to tax a 15H form should be submitted.
  3. The interest rate on Fixed Deposits was as low as 8% during the period December 06. This recent hike in interest rates over the past few months has been due to a number of reasons – good credit growth, tight supply of money, to control liquidity, etc. In addition, as it is commonly known, Feb-Mar is the end of the financial year and is a period wherein banks are hurrying to meet their annual fund targets. For the smalltime investor this means that these attractive interest rates may soon be withdrawn. While most public sector banks have extended their previous 31st March deadline by another month, private sectors are still non-committal about the cut-off date.

Update: April 11th, 2007

Post Archana’s comment I did realize that some clarification was required on the declaration to be filed for no deduction of tax.

For individual residents in India aged 65 and above, a declaration is required in Form 15H to the bank if the tax on his/her estimated income for the financial year is nil.

For citizens below 65, a declaration in Form 15G can be furnished by a depositor if the tax on his estimated total income for the financial year is nil and the aggregate amount of interest credited or paid (or likely to be credited or paid) during the financial year is not more than the maximum amount, which is not chargeable to tax (Rs 1 lakh for male taxpayers and Rs 1.35 lakh for a women). It is important to note that both the above conditions are required to be fulfilled.
Source: The Hindu, Nov 2006


Archana said...

Interesting read Arthi..I think reading ur blog is the only way to keep myself abreast of the latest in the finance world....

btw is'nt Form 15H for senior citizens??

Arthi Ramaswamy, India said...


Thanks a lot for pointing that out! The form under question is not the 15H form which, as you rightly pointed out is applicable for citizens aged 65 and above. The same declaration can be made by citizens below 65 years of age but under specific circumstances only.

I realized the importance of clarifying this as soon as you pointed it out. Please find the post updated with the relevant details.

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