FD interest: In recent years, fixed deposit (FD) investors have benefitted from higher interest rates, driven by the effects of the coronavirus pandemic and the economic climate. Fixed deposits, or FDs, are investment tools provided by banks and non-banking financial companies (NBFC) to their customers. With an FD, individuals invest a specific amount of money for a set period at a predetermined interest rate. Interest rates can vary among financial institutions but are typically higher than those offered by savings accounts.
Approximately 65% of Indian investors prefer fixed deposits or other fixed-income investments. However, many individuals lack a clear understanding of how FDs operate and how interest is calculated on their investments.
Explaining the fixed deposits in a podcast with Figuring Out, Saurabh Jain, Co- Founder of Stable Money, said the return calculation in fixed deposits is not fully known and has a lot of confusion.
“If you invest Rs 100 at 9% interest rate, what would you get after a year. Most investors would think Rs 109. But that’s not the case with FDs. The 9% interest rate on a fixed deposit is applicable to one quarter. So, for a quarter, an investor is earning Rs 9 divided 4 and this amount is again invested. Therefore, you will realised that your FD is actually offering you an interest of 9.3% at the end of the year. It is just as per RBI’s guidelines the rate is defined like this.”
FD and its mechanism
Investing in a Fixed Deposit (FD) entails the financial institution committing to return the invested amount upon maturity, alongside accruing interest. The bank utilises these funds to provide loans to other customers, charging them interest in return. A fraction of this interest is then passed on to the investor. The interest rate offered is determined by the duration of the FD. For instance, a 7-day deposit will yield a lower annual interest rate compared to a one-year FD.
Cumulative Fixed Deposits (FDs) differ from non-cumulative FDs in terms of interest payout structure. When opting for a Cumulative FD, both the principal and interest are paid out upon maturity, with the interest being reinvested annually. This means that regular interest payouts are not received, and instead a lump sum is given at the end of the FD tenure. If you do not require a steady income stream, the cumulative FD option may be suitable for you. Additionally, the power of compounding is leveraged in this option, as the interest for the following year is calculated on the previous year’s principal and interest.
On the other hand, non-cumulative FDs pay out interest at fixed intervals, such as monthly, quarterly, half-yearly, or annually, based on your preference. This ensures a regular income flow for you. However, a drawback of non-cumulative FDs is that the opportunity to earn interest on interest is forfeited.
FDs in your portfolio
Investing in a fixed deposit guarantees that the duration of the investment, interest amount, and maturity date are all predetermined. The institution providing the fixed deposit also guarantees to return your money at the end of the investment term, making FDs a secure investment option. Fixed deposits offer stability to your investment portfolio, unlike market-linked instruments such as equities and mutual funds which carry a higher risk factor. Even during market downturns, the returns from FDs can help to keep your portfolio’s overall value positive, as the interest earned from FDs can offset any losses incurred by your market-linked investments.
Jain said 25-30% of your funds can be parked in the fixed deposits to get some incremental money in a year rather let them be in the savings account.
“You can put your 25-30% of funds in fixed deposits as this would give your sure shot fixed return. This can help people in building an emergency fund. People who have a lot of responsibilities or who are heavy investments in markets or can have a dry patch in their career, FDs can give you a stable income and balance out your portfolios.”