Most investors seeking liquidity invest in an FD since it is one of the safest investment products. An FD enables you to put in a particular sum of money for a determined amount of time without any risk. It provides a guaranteed interest rate regarding the FD amount and the corresponding tenure.
Before investing in an FD, you should know the interest rate accrued. To do that, you need to understand how fixed deposits work, their types of interest, and the interest on the FD formula.
How does a Fixed Deposit work?
A Fixed Deposit can only be opened when making a single deposit. The amount of money you put in is known as the principal. You receive interest on the deposited amount for a fixed term. The interest rate is fixed a priori and can change due to various factors. Any person with a bank account can start an FD. The minimum deposit amount is 1,000, and the minimum tenure is seven days.
Your FD, upon maturation, entails the transfer of the principal sum and interest. If the payout frequency is monthly, quarterly, semi-annually or annually, you earn interest periodically.
How to Calculate Fixed Deposit (FD) Interest
Formula for Simple Interest (SI):
The formula for calculating simple interest is:
SI = (P × R × T) / 100
Where:
- P = Principal amount
- R = Interest rate per annum
- T = Tenure in years
Example:
- Principal amount (P) = ₹2,00,000
- Interest rate (R) = 8% per annum
- Tenure (T) = 2 years
Using the formula for simple interest:
SI = (2,00,000 × 8 × 2) / 100 = ₹32,000
So, if you deposit ₹2,00,000 in a fixed deposit for 2 years at an 8% simple interest rate, you will earn ₹32,000 in interest over the tenure.
The formula for Compound Interest (CI):
The formula for calculating compound interest is:
A = P (1 + R/N)^(N × T)
Where:
- A = Total amount (Principal + Interest)
- P = Principal amount
- R = Interest rate per annum
- N = Number of times the interest is compounded per year
- T = Tenure in years
Example:
- Principal amount (P) = ₹2,00,000
- Interest rate (R) = 8% per annum
- Tenure (T) = 2 years
- N = 1 (assuming the interest is compounded annually)
Using the compound interest formula:
A = 2,00,000 × (1 + 0.08/1)^(1 × 2)
A = 2,00,000 × (1.08)^2
A = ₹2,33,280
To calculate the compound interest (CI), subtract the principal from the total amount:
CI = A – P
CI = ₹2,33,280 – ₹2,00,000 = ₹33,280
Thus, the interest earned on a ₹2,00,000 fixed deposit at an 8% per annum interest rate, compounded annually for 2 years, will be ₹33,280.
Key Differences Between Simple and Compound Interest
- Simple Interest: Interest is calculated only on the principal amount. For a ₹2,50,000 FD at 8% for 2 years, you will earn ₹32,000 in interest.
- Compound Interest: Interest is calculated on both the principal and the accumulated interest, leading to higher returns. Depending on the terms of the FD, compound interest can be compounded annually, semi-annually, quarterly, or monthly.
Summing up:
Return calculations for Fixed Deposits can be challenging, mainly when dealing with prominent figures. On the other hand, you can receive larger returns after the investment period if you understand how the Fixed Deposit is calculated.
An online Fixed Deposit interest calculator eases out calculations. It can be helpful to estimate at once how much money, if any, you will earn with different principal amounts deposited with various maturities and an interest rate fixed by the financial institution or bank.
