When we compare Fixed Deposits, most of us look at just one number. The interest rate.
7 percent sounds the same everywhere, right? Not really.
There is a small but powerful detail working quietly in the background that can change your actual returns. It is called compounding frequency.
Why compounding matters more than you think
Compounding decides how often your interest is added back to the principal and starts earning interest on its own. The more frequently this happens, the better it is for you as an investor.
Same rate. Same tenure. Very different outcomes.
Let us take a simple example. Two banks advertise the same interest rate for the same 2 year FD.
| FD Issuer | Bank A | Bank B |
|---|---|---|
| Interest rate and Tenure | 7% p.a. for a 2Y FD | 7% p.a. for a 2Y FD |
| Compounding Frequency | Annual | Monthly |
| Effective rate | 7% p.a. | 7.23% p.a. |
Since Bank B compounds interest every month, your interest starts earning interest much faster. Over 2 years, this creates a noticeable gap in returns.
Assume you invest ₹5 lakh.
-
Interest earned with Bank A: ₹72,450
-
Interest earned with Bank B: ₹74,905
That is ₹2,455 more, earned simply because of a higher compounding frequency.
This extra interest may look small at first glance. But as the investment amount increases or the tenure becomes longer, the impact of compounding becomes much more meaningful.
A quick rule to remember
For cumulative FDs, higher compounding frequency works in your favour. Monthly > Quarterly > Annual
But there is an important exception
Banks usually do not compound interest for short term FDs. If the FD tenure is 181 days or less, interest is generally calculated using simple interest. Compounding does not come into play here, regardless of which bank or NBFC you choose.
The takeaway
Interest rate tells only half the story. Compounding frequency tells the rest. The next time you compare FDs, do not stop at the headline rate. Look one level deeper and check how often interest is compounded. That single detail can quietly boost your returns without taking any extra risk.
Have you ever checked compounding frequency before booking an FD, or do you usually stop at the interest rate?