– Does the above ticker looks/sounds familiar?
YES, its not uncommon to see the above ticker advertisement on various media platforms – print, tv, internet, mobile… its almost everywhere.
AND eye-popping returns in the above ticker generally gets registered in our minds and generates more curiosity and bias…
Important thing to note in the above tickers is the ” * “, and if you try to read the fine print details, above returns are referred as “Annualized Returns/Yield with Cumulative option”
Lets try to decode Fixed deposit returns
Each fixed deposit has following important parameters:
1. interest/coupon rate – represented as % pa
2. interest/coupon frequency – yearly, half-yearly or quarterly
3. cumulative/non-cumulative option – interest/coupon reinvest or payout option
4. duration – period of fixed deposit
Depending on how we do crunching of the above parameters, we can derive 2 types of returns – Annualized returns or CAGR.
Consider a fixed deposit with 9.5% pa interest rate, quarterly interest frequency and cumulative option
That’s how the 2 magical returns looks like for different durations –
– Annualized Returns = 11.9% whereas Actual CAGR = 9.84%
– Annualized Returns = 15.5% whereas Actual CAGR = 9.84%
Here’s the catch – as duration increases Annualized returns increases just because of the compounding effect, though CAGR is same
While considering fixed deposits with cumulative option and for 1 year+ time horizon –
~ CAGR is a much better reflection of returns vis-a-vis Annualized Returns
~ interest/coupon frequency is the only parameter that can change CAGR
We seldom see CAGR projections for fixed deposits, whereas its very common to see Annualized Returns.