What is Derived Interest?

Malcolm Tatum

Derived interest is a broad term that is used to refer to any type of interest income that is obtained from some sort of investment. Not to be confused with dividends, derived interest is usually associated with any type of interest bearing account or investment strategy where the investors earns a fixed or variable rate of interest in return for placing funds into an account or purchasing a bond of some type. Investments yielding derived interest tend to be relatively risk free, although the return is usually somewhat low.

Businessman with a briefcase
Businessman with a briefcase

One of the most common means of accumulating derived interest is by setting up accounts at a local bank. The savings account provides an easy way to accumulate interest over a period of time. Most savings accounts have a fixed interest rate. Periodically, the current balance in the account is evaluated and an interest payment is deposited directly into the account. While the interest derived is usually a small percentage, incrementally depositing small amounts of funds and allowing the balance to accrue interest can eventually provide a decent nest egg.

Along with a savings account, your local bank offers a few other ways to accumulate derived interest. Certificates of deposit are a common type of safe investment used by many depositors today. Providing a higher rate of interest than the standard savings account, the funds in the CD cannot be removed without severe financial penalties. The end result is that the funds remain in the account untouched for longer periods. The interest derived from a certificate of deposit can be added back to the balance or transferred into a savings or check account.

Bonds are another means of accumulating derived interest. The simple savings bond pays a fixed rate of interest. Upon reaching maturity, the bond will pay off the face value plus the derived interest. Municipal bonds work much in the same way, in that the amount paid to the investor upon maturity will include both the initial investment and the agreed upon amount of interest. As with the interest bearing options at the local bank, bond issues are relatively stable and earn as smaller return than riskier investment ventures.

These low risk means of creating derived interest generally do not require a huge outlay of cash at the beginning of the effort. This means that people with limited income can still begin to build nest eggs using these low return investments. As the balances grow, the amount of interest accrued will also increase, although the actual rate of interest usually remains the same.

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