How to Make the Most of Your FD Interest

A fixed deposit (FD) is a popular savings instrument that offers a reliable way to earn interest on your investment. Since FDs are considered a low-risk option, they are favoured by investors looking for stability. With fixed deposits, your principal amount remains secure while you earn interest over a fixed tenure. However, to maximise your FD interest, there are certain strategies and considerations that can help you make the most of this investment.

1. Choose an FD with a Higher Interest Rate

The most straightforward way to increase your returns from an FD is to choose one offering a higher interest rate. Interest rates on FDs vary based on the institution, tenure, and the depositor’s category (such as senior citizens). Banks and NBFCs offer competitive interest rates, and it’s important to compare the available options.

For instance, as of October 2024, some of the highest FD rates in banks range from 6.50% to 7.50% p.a. for tenures between one to three years. Senior citizens, however, often receive an additional 0.25% to 0.50% p.a. on their deposits.

Here’s a table showcasing the current interest rates for FDs by banks and NBFCs:

By comparing rates across institutions, you can identify the FD that offers you the best returns. Opting for an FD with a slightly longer tenure can also help increase your total interest earnings.

2. Opt for Cumulative FDs

Another key consideration is whether you want a cumulative or non-cumulative FD. In a cumulative FD, the interest is compounded and paid at the end of the tenure. This allows you to take advantage of compounding, which can significantly increase your returns. Non-cumulative FDs, on the other hand, pay out interest at regular intervals—monthly, quarterly, or annually.

Cumulative FDs could be a better option if you do not need periodic income from your FD and prefer to let your investment grow over time. The compounding effect in cumulative FDs helps to maximise your interest earnings.

For example, a ₹1,00,000 investment at 7.50% p.a. in a cumulative FD for three years could generate higher returns than if the same interest was paid out yearly.

3. Consider the Tax Implications

Though FDs are a low-risk investment, the interest earned is not exempt from taxes. It is classified as “Income from Other Sources” and taxed according to your income tax slab. As a result, it’s important to account for this tax liability when calculating your actual returns.

To minimise the impact of taxes, investors could use the following methods:

● Split Deposits

Distribute your FDs across multiple accounts or financial years to reduce the taxable income in a single year.

● Tax-saver FDs

These FDs come with a five-year lock-in period and offer tax deductions of up to ₹1.5 Lakhs under Section 80C of the Income Tax Act, 1961.

Although tax saver FDs offer deductions, the interest earned on these FDs is still taxable. Before making a decision, calculate your tax liability to understand the actual returns from your FD.

4. Select the Right Tenure

Selecting the appropriate tenure for your FD can significantly impact your returns. The interest rate offered on FDs varies depending on the tenure and choosing a longer or shorter tenure without careful consideration could reduce your returns.

• Short-term FDs (6 months to 1 year) may offer lower interest rates but could be useful for investors who need liquidity
• Medium-term FDs (1 to 3 years) generally offer better interest rates and a balance between liquidity and returns
• Long-term FDs (5 years or more) can lock in higher interest rates, but your money is inaccessible for a longer period

To make the most of your FD interest, match the tenure of the FD to your financial goals. If you foresee needing the funds in the short term, opt for shorter tenures, but if you can hold the investment for longer, you may receive higher returns by locking in the interest rates for an extended period.

5. Ladder Your FDs

Laddering your FDs is a useful strategy to ensure liquidity while still earning good interest. Laddering involves splitting your investment across multiple FDs with varying tenures. This way, you benefit from both higher interest rates on long-term FDs and liquidity from short-term FDs.

For example, instead of investing ₹5 Lakhs in a single three-year FD, you could split the amount into three FDs with tenures of one year, two years, and three years. When the one-year FD matures, you can reinvest the principal into another FD, potentially at a higher interest rate, depending on the market.

How to Calculate a Fixed Deposit’s Interest Rate

Understanding how to calculate a fixed deposit’s interest rate helps you plan your finances better. The interest on an FD is typically calculated using the following formula:

A = P (1 + r/n) ^ (nt)

Where:

• A is the maturity amount
• P is the principal amount
• r is the annual interest rate (in decimal form)
• n is the number of times interest is compounded per year
• t is the tenure of the FD

For example, if you invest ₹1,00,000 in a three-year cumulative FD at 7.00% p.a., compounded quarterly, your maturity amount will be calculated as:

• A = 1,00,000 (1 + 0.07/4) ^ (4 * 3)
• A = ₹1,23,105

Knowing how to calculate a fixed deposit’s interest rate helps you compare different FD products and choose the most favourable one.

Understand the Effect of Premature Withdrawal

Although FDs allow premature withdrawals, doing so typically incurs a penalty. Banks and NBFCs often reduce the applicable interest rate by 0.5% to 1% if you withdraw before maturity. This could significantly affect your returns, making it essential to avoid premature withdrawals unless absolutely necessary.

For example, if your FD offers 7.50% p.a. and you withdraw prematurely, the effective interest rate could drop to 6.50% or lower, thereby reducing your overall earnings.

Conclusion

To make the most of your FD interest, it’s essential to compare rates across banks and NBFCs, choose the right tenure, and consider cumulative options. By laddering your FDs, you can strike a balance between liquidity and returns. Also, don’t forget to account for taxes and the potential penalties for premature withdrawals, as these factors can affect your overall earnings.

By employing these strategies, you could ensure that your FD becomes a more effective savings instrument, helping you grow your wealth steadily over time.