Fixed Deposits have always been a popular investment avenue in India. They assure fixed returns through the tenor and protection from market volatility. Fixed Deposits are of two types: Non-Cumulative and Cumulative. A Non-Cumulative Deposit makes periodical interest payouts, while a Cumulative Deposit instead reinvests the interest and compounds it.
Why consider a Cumulative Fixed Deposit?
- Multiplier Scheme: The interest earned in the first year is added to the principal amount the next year and so on, implementing the multiplier effect on your investment. There is interest on interest earned. Thus, if the same amount of money were invested in a non-cumulative and cumulative FD respectively, for the same tenor, the latter would fetch a larger return.
Suppose, you have invested a lump sum of 1,00,000 rupees for three years in a non-cumulative fixed deposit at a 7% per annum interest rate with a monthly payment option. You will receive 583.33 rupees per month for the period of three years.
However, if you were to invest the same corpus in a fixed deposit at the same rate for the same tenure to be compounded on a quarterly basis, the interest at maturity would be 23,143.93 rupees, the rate effectively 7.71%.
Longer the tenure the more effective the multiplier is.
- Security: It is a fixed-income instrument. It pays a predetermined interest rate for the decided tenor no matter the fluctuations in market rates of other asset classes or even a change in the RBI’s repo rate. This is a preferred investment option for the risk-averse.
- Asset Allocation: No matter how large your appetite for risk is it is prudential to have a mix of high-risk, high-return equity fund investment and safer fixed-income products in your portfolio. This portfolio is more prepared to absorb shocks from the external economic environment. Dynamic asset reallocation helps optimize portfolio value and limits losses.
Is it the right product for you?
The effectiveness of an investment product depends on how suited it is to your objectives.
A cumulative Fixed Deposit does not make monthly interest payments. It isn’t suited for a retirement plan where one may have invested a certain lump sum so as to receive a budgeted sum as interest every month to run expenses.
However, it could be a useful instrument for those you are earning currently and can forego the periodical interest payments for some time. One could lock in a certain sum for a medium-term goal of five years. A longer tenure would fetch a higher interest rate and provide more time for compounding.
Non-bank finance companies provide higher returns on deposits as compared to banks. You can find fixed deposits for a tenor of a year to five years at lucrative rates at Finserv MARKETS.
In a Nutshell: If you are saving for a medium-term goal where you would want to protect your corpus from external uncertainties such as market fluctuations, cumulative FDs would be an ideal instrument.
