Introduction
In India, fixed deposits are considered one of the most popular investment options available in the market. A fixed deposit is considered interchangeably as an investment, in the common person’s perception conventionally, and the reason behind this is that FDs are considered safe, promise fixed returns, and have come in a variety of options according to the time period to suit the investor’s needs.
Irrespective of the fluctuations in the interest rates or GDP performance, the returns promised by a fixed deposit are rock solid. It also helps its investors benefit from the compounding effect, by which, they are paid interest over their subsequent interests year over year.
Summary in Brief
- What is a Fixed Deposit?
- How does a Fixed Deposit Work?
- Non-Cumulative Fixed Deposit
- Who Should Invest in a Non-Cumulative Fixed Deposit?
- FAQs
What is a Fixed Deposit?
Fixed Deposit is one of the safest investment alternatives available in the market for a long time. It is an investment through which people earn a comparatively high-interest rate than a standard savings account provides. The maturity period is flexible and the investor is provided with options to suit their needs. Once the investor enters into an agreement and makes the investment, the time period for the investment remains unchanged, however, the investor can pull back from the investment and can easily liquidate their funds in case of an emergency. The interest rate remains constant irrespective of the market fluctuations, hence, there is minimal risk involved as the promised return is fixed and unaffected.
How does a Fixed Deposit Work?
A fixed deposit acts as a loan given to the Bank or the Non-Banking Financial Corporation by the investor. The institution promises to return the loan within a specified period of time and even pays interest to the investor at the end of the period, also called the maturity period. The institution uses this money for their own purposes, for example, a bank may use this money to further lend it to other account holders looking for a loan. A part of the interest the bank earns on these loans is passed onto the investors of fixed deposits.
The interest rate promised by the bank depends on factors such as the maturity period of the fixed deposit, for example, a 1 month fixed deposit will fetch a lower rate of interest as compared to a 10-year fixed deposit for the same amount. The reason for such a disparity is that the investor must be compensated for the risk that they bear while investing their money for longer periods. The common concept of time-risk of money says that a rupee's value would go down with time as inflation results in the rupee fetching you comparatively fewer goods in the future.
What is a Non-Cumulative Fixed Deposit?
For a Non-Cumulative Fixed Deposit, the interest that accrues on the investment is paid out, yearly, half-yearly, quarterly, or monthly. The investor is provided the option to choose a payout time period and they receive the payment of their accrued interest according to the same frequency. The amount supposed to be received on maturity continues to decrease. This is because the return promised at the end of the tenure of the fixed deposit is paid out on a regular basis. The interest paid out is taxable as and when it is received by the investor.
The scheme offers a maturity period varying from 6 months to a period of 10 years. This type of fixed deposit is suited for investors who might be looking for a low but steady stream of recurring income, the likes of retired individuals.
Let us take an example to understand the functioning and the calculations of a non-cumulative fixed deposit investment. Suppose an investor opens up a fixed deposit account with a bank for ₹10,00,000 for a period of 10 years. The bank provides its investors an interest rate of 6% per annum on fixed deposits. Now, because it is non-cumulative meaning the investor would not be entitled to benefit from the compounding interest year after year, they shall be eligible to receive a fixed amount of payout for a preselected frequency monthly, quarterly, half-yearly, or yearly. Let’s say the investor wishes to receive the payout every month.
The investor would receive interest monthly for the same amount calculated below,
Principle Amount x Interest Rate per annum x 1/12
= ₹ 10,00,000 x 6% x 1/12
= ₹ 5,000 per month
The total interest earned per year would amount to ₹ 60,000. The yearly amount of ₹ 60,000 would be taxable for that particular year in the case of a non-cumulative fixed deposit.
Who Should Invest in a Non-Cumulative FD?
This type of fixed deposit which provides a steady stream of regular income is suited for investors who do not have a stable income or no income, such as homemakers, people looking to make passive income, retired individuals, freelancers, etc. Although the interest payout received is not a very huge amount, it can surely help in financing the short-term needs of such individuals.
How can I start to invest in a fixed deposit?
Any individual can start investing, by opening an FD account with their favorable bank or financial institution. They need to fill in the required forms to enroll for an account and await KYC approval. Once, the formalities are complete, one can choose the best-suited investment plan and commence investing.
What is the minimum age to invest in a fixed deposit?
A fixed deposit can be made in the name of a child as young as one year old, but, it is managed and registered as a dependent account with their guardian or parent. However, an individual can invest in a fixed deposit if they are above the age of 18 years.
Is it possible to withdraw my investment in a fixed deposit before the maturity period is over?
Fortunately, the majority of banks provide the investor the option to withdraw their money from the fixed deposit in case of an emergency as and when required. However, there is a small penalty fee that is levied by the bank/ financial institution for premature liquidation. The investor is not entitled to the interest to be accrued for the rest of the maturity period from the time of premature liquidation. Such a withdrawal is, however, not possible in the case of a tax-saving fixed deposit.