There are two types of fixed deposits offered in India, cumulative fixed deposit and non-cumulative fixed deposit. Both the FD types offered by banks help depositors to reap the maximum benefits from their investments. Though similar in nature, both suit the needs of different groups of people and serve different purposes.
Now, let’s check the basic difference between both types of FD schemes.
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In this type of FD, the interest component and principal amount are paid at maturity. The interest is compounded at every quarter. It means the interest earned is added back to the principal amount every quarter. This helps you earn a higher interest on FD until maturity.
The interest income in this FD type is paid out at regular intervals on a monthly, quarterly, semi-annual, and annual basis as per the investor’s choice. As the interest is paid out at regular intervals, the principal amount remains the same at the end of the tenure, and it misses out the benefit of compounding interest as a result, which increases the investment yield.
As you can notice, both the FD types serve two distinct interests for different groups of people.
Cumulative FDs help you grow your wealth and build a corpus by saving a lump sum amount. It is suitable for individuals who seek to grow their wealth over a longer period and want to avoid the riskier asset class like mutual funds and equities.
Whereas, non-cumulative FD helps you earn an interest income at regular intervals for meeting your daily expenses. This option is most suitable for individuals like retirees and pensioners, who need a constant flow of steady income from their savings to meet their daily expenditure.
In terms of returns from FD, the cumulative FD type offers superior returns over non-cumulative FD types because of the compounding interest factor. Further, in cumulative FD, the interest is compounded quarterly, which helps you yield the maximum returns from the investment.
For example, Rs. 10 lakhs invested in a cumulative FD at the rate of 8% for a period of 5 years will earn you an interest income of Rs. 4,89,845 at maturity.
Whereas, in the non-cumulative option (interest is calculated using simple interest formula), total interest income after a 5-year period will be Rs. 3,31,996, which is a difference of almost Rs. 1.58 lakh. There will be some variations in interest income in different payout intervals.
The difference between both the FD types is based on the payout of the interest component, which makes the difference huge. One reinvests the interest component during the whole tenure of the FD, and the other makes periodic payments of the interest earned on the deposit.
In terms of choosing the right FD type, there is no right or wrong, as both serve different interests of a diverse audience. Therefore, irrespective of the choice, both the fixed deposit types offer numerous benefits to its investors, which makes it the most sought-after financial instrument in the market.