A fixed deposit (FD) is a popular financial instrument offered by banks and financial institutions that allows individuals to deposit a specific amount of money for a predetermined period at a fixed interest rate. This investment option can be categorised into two main types- cumulative and non-cumulative fixed deposits, each offering unique advantages for investors.
What is Cumulative Fixed Deposit?
A cumulative fixed deposit is a type of investment in which the interest earned on the principal is reinvested and distributed at the end of the maturity period. This means that interest builds up over time instead of being paid out regularly. As a result of the compounding effect, compounding fixed deposit results in giving more significant overall returns. People who can afford to have their money invested for a more extended period and want to maximise their profits can consider investing in cumulative fixed deposits.
What is Non-Cumulative Fixed Deposit?
A non-cumulative fixed deposit is a variation in which the interest gained is paid out to the investor at monthly, quarterly, or yearly intervals, depending on the selected payout frequency. For individuals looking for a consistent cash flow or additional income, non cumulative fixed deposit offers a reliable revenue stream. Non-cumulative fixed deposits are better suited for people with frequent interest access needs or short-term financial goals.
Features of Cumulative Fixed Deposit
- Compounding effect: The compounding effect occurs when interest is reinvested, increasing returns over time.
- Higher Total Returns: Suitable for long-term investors looking for the highest rate of return.
- Maturity payout: The interest and principal are paid jointly after the deposit term.
- Long tenure: To fully benefit from compounding, cumulative FDs often have more extended maturity periods.
- Limited access to interest: The liquidity is reduced because interest can only be withdrawn once maturity.
Features of Non-Cumulative Fixed Deposit
- Regular payouts: Interest earnings are distributed at fixed intervals, whether monthly, quarterly, or annually.
- Stable income stream: Perfect for people who need steady financial flow. Options with shorter terms are available to meet short-term financial objectives or extra revenue requirements.
- Immediate liquidity: Interest can be accessed while the deposit is open, improving financial flexibility.
- Lower total returns: Returns may be less than cumulative FDs because there is no compounding impact.
Also Read: Open a Fixed Deposit Account Online
Benefits of Cumulative Fixed Deposit
- Growth through compounding: Cumulative FDs use compounding to produce rapid growth over time—increased returns on the principal and accrued interest result from the reinvested interest.
- Higher overall returns: Compared to non-cumulative fixed-rate deposits with the same interest rate, long-term investors can use the compounding effect to produce larger yields.
- Goal-oriented savings: Cumulative FDs are perfect for people with long-term financial goals, such as purchasing a home, paying for college, or accumulating savings for retirement.
- Capital appreciation: The principal and cumulative interest are added together at maturity, raising the investment’s total value.
- Discipline saving: Because the interest is locked until maturity, it promotes saving with discipline and discourages impulsive withdrawals.
Benefits of Non-Cumulative Fixed Deposit
- Predictable income stream: Non-cumulative FDs give consistent interest payments, providing investors who require recurring cash flow with a predictable income stream.
- Short-term objectives: These deposits are appropriate for short-term financial goals like managing urgent expenses or covering unexpected costs.
- Liquidity: Investors have better liquidity with frequent interest payments than cumulative fixed-rate debt (FDs), where interest is locked until maturity.
- Flexibility: Non-cumulative FDs offer a range of payout frequencies, letting investors select the one that best suits their income requirements.
- Diversification: When paired with other investment vehicles, non-cumulative FDs can help investors balance risk and return in their portfolios.
Drawbacks of Cumulative Fixed Deposit
- Limited access to interest: Cumulative FD interest cannot be withdrawn before maturity, limiting access to money in an emergency.
- Opportunity cost: Due to the locked-in interest, investors may pass up possible investment opportunities with higher yields throughout the deposit period.
- Impact of inflation: Because the interest rate on cumulative FDs is fixed, they might need to provide more protection against inflation.
Drawbacks of Non-Cumulative Fixed Deposit
- Lower total returns: Due to the absence of compounding, non-cumulative FDs typically offer lower yields than cumulative FDs.
- Reinvestment risk: When renewing a deposit beyond its initial term, investors may need help finding similarly alluring interest rates.
- Taxation: Regular interest payments made on non-cumulative FDs may be taxed, which might lower investors’ after-tax returns.
Investors looking to increase their money through safe and reliable means have two unique options: cumulative and non-cumulative fixed deposits. A cumulative fixed deposit is appropriate for those looking to build long-term wealth since it permits the interest to compound throughout the term, resulting in higher overall returns at maturity. A non-cumulative fixed deposit, on the other hand, provides a consistent distribution of interest at predetermined intervals, making it more alluring to people who need periodic income to meet their financial obligations. The decision between these two fixed deposit kinds ultimately comes down to the client’s precise financial goals, risk tolerance, and income needs.