Fixed Deposits continue to be the most popular investment option for millions of Indians despite numerous options available to them. Its flexibility in terms of instant liquidity, interest payment mode, and guaranteed returns is what makes it a truly unique investment option.
And, for this reason, several people prefer to invest their life savings in FDs without giving it a second thought. It is essential to know that Fixed Deposits are of two types, cumulative FD and non-cumulative FD.
Here, we will take a look at the features and usefulness of both these variants.
This scheme is also known as reinvestment fixed deposit. Under this FD option, the interest accrued is compounded with the principal amount at a regular interval until the tenure of the investment ends. It results in higher yield and offers you a large corpus at the end of the period. Therefore, it is also called the money-multiplier scheme.
Here, the FD interest rate is paid to the borrower at a regular interval. Usually, the interest is paid out on a monthly, quarterly, half-yearly, and yearly interval as per the investor’s choice.
As the interest component is paid out at regular intervals, the principal amount is only paid at maturity. One of the major advantages of non-cumulative FD is that it allows a person to get a fixed income. It is most beneficial for senior citizens and others who do not have a regular income source.
Calculation of Interest
The interest calculation method is different for both FD variants. The cumulative FD interest is calculated using the compound interest method and non-cumulative variant is calculated using the simple interest method.
For example, if you deposit Rs. 1 Lakh under the cumulative FD option for a 3-year tenure with afixed deposit rate of 8.5%. Then you will receive a total sum of Rs 1,28,930 at maturity.
Under non-cumulative FD option, with quarterly interest payout, you will receive an interest payout of Rs 2,140. The total FD interest payment stands out to be Rs 6,420 annually and Rs 19,260 at the end of three years time period. The total benefit is almost Rs 10,000 less compared to the cumulative FD variant. But, then it is better to earn less than take a loan to meet your expenses.
Which FD Type Should You Choose?
Banks offer both the options, and choosing the variant comes down to your financial status at the time of depositing the money.
Cumulative FDs are suitable for long term deposits. It is suggested for individuals who want to earn interest without putting the principal at risk.
Whereas, non-cumulative FD is a suitable option for retired personnel and senior citizens looking for a regular income. It ensures liquidity to meet their daily expenses.
One point is to be noted that the interest payouts under non-cumulative FDs are taxable as per the tax slab rate you fall under. It decreases the overall return benefits. But, under cumulative FD, you can invest in tax-free FDs (maximum 5-years tenure), which helps you to pocket the total benefit.
Both FD variants are unique in nature, serve different purposes, and have their advantages and disadvantages.
In terms of returns, cumulative FDs come out as the best option because of its higher yield, but in terms of liquidity, non-cumulative variants offer the best outcome.