How RD interest is calculated, and why it looks too small

Open a recurring deposit at 7%, pay in ₹5,000 a month for five years, and you will have deposited ₹3,00,000. The maturity value is about ₹3,59,664.

That is ₹59,664 of interest — a little under 20% of what you put in. Seven per cent for five years sounds like it should be 35%, or ₹1,05,000. The difference is large enough that people assume the bank has short-changed them.

It has not. The rate is exactly what was advertised. What is different is how long your money was actually in the account.

The money arrives late

A fixed deposit takes your money once, at the start, and every rupee earns for the whole term. A recurring deposit takes a slice each month.

Your first instalment is in the account for all 60 months. Your second is in for 59. The last one you pay is in for a single month before the deposit matures. Average that out and the typical rupee has been earning for about 30.5 months — a little over two and a half years, not five.

So the correct comparison is not "7% for five years". It is closer to "7% for two and a half years, on average". Seen that way, 20% is about what you would expect.

The formula

Indian banks compound recurring deposits quarterly. The maturity value is the sum of every instalment, each grown for the months it was held:

The exponent is $k/3$ because interest compounds once a quarter and a month is a third of a quarter.

That sum has a closed form, and it is the one the Indian Banks' Association publishes and bank calculators use:

The two expressions give the same number to the paisa. The second is just quicker to compute.

Worked through, with the numbers above

₹5,000 a month, 7% a year, 60 months.

The quarterly rate. 7 ÷ 400 = 0.0175. Note the 400: that is 4 quarters and the conversion from per cent, in one step.

The number of quarters. 60 ÷ 3 = 20.

Growth over the tenure. 1.0175 raised to the power 20 = 1.4147782. A rupee left in for the whole five years would become about ₹1.41.

The monthly adjustment. $1 - (1.0175)^{-1/3} = 0.00576619$. This is the part that accounts for instalments arriving monthly while interest compounds quarterly.

Maturity value. ₹5,000 × 0.4147782 ÷ 0.00576619 = ₹3,59,664.

Deposited: ₹3,00,000. Interest: ₹59,664. As a share of deposits: 19.89%.

You can change any of those numbers in the RD calculator, which shows the same four steps with whatever you enter.

The same money as a lump sum

If you already had ₹3,00,000 and put it in a fixed deposit at the same 7% for the same five years, compounded quarterly, it would mature at about ₹4,24,433 — ₹1,24,433 of interest, roughly twice the RD's ₹59,664.

That is not an argument for one over the other. It is the same arithmetic seen from the other side: the lump sum earns more because all of it was invested for all of the time. Most people opening an RD do not have the ₹3,00,000 yet — that is the point of an RD. The comparison is only useful for understanding where the difference comes from, not for choosing.

Shorter deposits look worse still

The shorter the tenure, the more the "late money" effect dominates. ₹5,000 a month at 7% for 12 months pays ₹2,311 on ₹60,000 of deposits — about 3.85%, against a headline rate of 7%.

Nothing is wrong there either. Over one year the average instalment has been invested for six and a half months.

What the rules say

RBI's Master Direction on interest rates on deposits provides for recurring deposits compounded quarterly, accepted for periods in multiples of three months, up to a maximum of ten years. Banks set their own rates within that framework, and those rates change — the 7% used here is an illustration, not a quote.

What this calculation leaves out

• Tax. RD interest is taxable as income at your slab rate, and banks deduct TDS on it once it crosses a threshold set in the Income Tax rules. The figures above are before tax.
• Missed instalments. Banks usually charge a penalty for a late or missed instalment, and repeated misses can lead to the account being closed. The formula assumes every instalment arrives on time.
• Inflation. ₹3,59,664 in five years does not buy what ₹3,59,664 buys today. At 6% inflation it buys roughly what ₹2,68,762 buys now. The RD calculator has an option that shows this.
• Rounding. Banks credit interest at each quarter end and may round at each step, so a bank's maturity figure can differ from this one by a small amount. Where a bank quotes a maturity value, that figure is the one your deposit will pay.

The short version

An RD's interest looks small because the rate applies to money that mostly has not been there long. If you want to know what a deposit will actually pay, compute it — the arithmetic above is four steps, and the RD calculator does them with your own numbers. For the lump-sum side, the FD calculator shows what changes when the whole amount is in from day one.