Understanding the basic difference between quarterly and annual compounding is crucial to be able to comprehend how a given fixed-income instrument--like an FD or savings account--works, and how your money grows in such financial products.
Interest is calculated and added 4 times a year (1 year has 4 quarters). For example, an annual interest rate of 6% will be spread out to 1.5% in each quarter.
Yes, always remember: the higher the frequency, the better the return.
Interest gets more opportunities to grow in a higher frequency of compounding. This is why 6.0% per annum compounded quarterly is a better return than 6.0% per annum compounded annually.
In annual compounding, interest is calculated and added fully and once at the end of each year. Hence, there is no need to divide 6% into 4 in annual compounding.
Typically, FDs are quarterly compounded.
Let's say we make a lump sum investment of Rs 1 lakh each in two fixed-income instruments, one paying 6% compounded annually and the other paying 6% compounded quarterly.
How much money will you have at the end of 1 year in each case?
In annual compounding, it will be Rs 1,06,000, and in quarterly compounding, it will be Rs 1,06,136.