The process of wealth creation requires discipline. Money must be put away systematically, over a period of time for wealth to grow.
Whether you choose to invest in the stock market, commodities market, mutual funds or even opt for conservative methods of savings such as fixed deposits and recurring deposits; each way of savings comes with its own set of features and benefits.
The two forms of deposit we will explore in detail, recurring and cumulative fixed deposits, have proved to be popular means of investment for those earning a regular income and especially for the risk averse investors.
But many a times, investors get confused if they have to invest in a RD plan or a FD scheme.
Both RD and FD are fixed income products that are offered by all major banks and financial institutions. In both the schemes, you can invest a specific amount and on the amount invested, you will receive a fixed interest.
At the end of tenure, investors will receive both the capital as well as the interest.
In both the schemes, you can invest a specific amount and on the amount invested, you will receive a fixed interest.
But a question that has constantly been raised is which of the two is better and which should you choose. But to choose, one should first understand what makes the two different.
By understanding the differences, one would be able to narrow down why either one would make a better choice, whatever be the income you earn in a month – be it salaried or otherwise.
Recurring versus fixed deposits
A recurring deposit or RDs simply refers to a disciplined way of putting away a fixed sum of money in an account every month.
One needs to open a special recurring deposit account and can earn the same interest rate as offered on fixed-deposits or FDs.
As the term ‘fixed’ suggests, one cannot withdraw money from a FD until the end of the term. Should you choose to ‘break’ your FD prematurely, you have to pay a penalty to the bank.
Investors can put away their idle savings in an FD and earn a specific rate of interest, which is higher than the interest accrued when the money is sitting idle in the savings account.
RDs, on the other hand, allow one to inculcate a disciplined habit of saving a fixed sum of money every month.
You can open a fixed deposit for a minimum duration of 7 days, whereas the maximum duration of the deposit is about 10 years.
On the other hand, the minimum duration for the RD is six months, whereas the maximum deposit tenure is 10 years.
For a recurring deposit, the interest rate varies between 5.25 per cent to 7.90 per cent for a tenure of one year – the rate of interest usually depends on tenure and monthly investment amount.
For fixed deposit, the interest rate varies between 6.96 per cent to 8.00 per cent - the interest rate depends on the capital and tenure opted for.
The interest rate for FD is slightly higher than that of RD.
Whereas for RDs, income tax will be not deducted if the interest you earn on your RD is up to INR 10,000.
We will briefly explore how taxes apply to NRIs investing in fixed deposits.
• NRE and NRO fixed deposits
An NRE FD is a type of term deposit account where the NRI makes deposits from overseas and remit the same in an Indian account, where the currency will be converted into rupees.
An NRE deposit is basically a term deposit account held to transfer foreign earnings.
An NRO account is usually opened by an NRI in order to manage the income that is earned in India. This income can be in the form of rent, pension or other types of dividends. The interest earned from these deposits are taxable.
NRO FDs do not offer repatriation (converting foreign currency to local currency) option on the principal investment. Only the interest earned from your NRO FD can be transferred to a foreign account.
NRE fixed deposits offer the option for full repatriation of funds including both principal and accrued interests to a foreign account.
These accounts therefore simplify the process of transferring principal and earned interests from an Indian account to a great deal.
Go for an NRE FD is you want to mainly park funds from foreign countries and want the currency to be fully repatriable.
On the flip side, it is best to go for an NRO deposit if you want to park your Indian earnings.
To summarize, bank FDs are secure and give you the option of receiving a lump sum interest income at the end of the tenure and regular pay-outs, depending on the type of FD you choose.
Let’s now look at the key features of the FD variants.
Non-cumulative fixed deposits offer a regular payout to investors. In a cumulative FD product, the interest accrued on your investment is reinvested
Cumulative versus non-cumulative
Non-cumulative fixed deposits offer a regular payout to investors. These periodical payouts could be on a monthly, quarterly, half-yearly or yearly basis.
For example, you have invested INR 100,000 (Dh4,826) for three years in a non-cumulative FD with monthly interest payout option.
If the interest offered by the bank is 8 per cent a year, you’ll get interest income of INR 666.66 (8% of 100000/12) (Dh32) every month through such investment i.e., INR 8,000 (Dh386) in one year.
Non-cumulative fixed deposit periodical payouts could be on a monthly, quarterly, half-yearly or yearly basis.
In a cumulative FD product, the interest accrued on your investment is reinvested, and hence you get the benefit of compounding return (explained in detail below). So, the yield gets added to the principal amount.
Say, you invested INR 100,000 in a cumulative FD for one year at interest 8 per cent annually, compounded on a quarterly basis.
On completion of the tenure, you’ll get interest income of INR 8,234.2 (Dh397.4), i.e. an absolute return of 8.24 per cent.
With cumulative FD product, you get the benefit of compounding return - so, the yield gets added to the principal amount.
To get a clear idea on how compounding interest works in cumulative FD, here is an example:
The interest is essentially calculated on your entire new balance of Dh840 at each term’s end rather than the starting principal amount.
The following table shows that balance at the end of each year and the interest that will be added.
Minimum amount under cumulative deposit is INR 10,000 (Dh482.62) and under non-cumulative scheme is INR 25,000 (Dh1,206).
Which type of deposit should you opt for?
Now that we have made clear the immediately related types of deposits, let’s go back to the first question we based this article on and weigh out which should an investor, such as yourself, opt for.
Like any investment, it all depends on your need. While non-cumulative FDs are suitable for investors looking for a regular income, such as retirees or pensioners, this implies that they can invest a lump-sum amount in a non-cumulative FD and earn a regular income every month.
Like any investment, it all depends on your need.
Cumulative FDs are suitable for creating a deposit over a longer term. The interest rate on a cumulative FD is usually higher than that of a non-cumulative FD and that of a recurring deposit.
FDs, as touched upon earlier, are secure and give you the option of receiving a lump sum interest income at the end of the tenure.
But if you have never invested in a savings scheme before, there is no better way to start than by investing in a recurring deposit.
With RDs you can put away savings every month until a more substantial amount of money is accrued, and then you can always put it away as a cumulative FD next.
If you have never invested in a savings scheme before, no better way to start than by investing in a RD.
And with a cumulative FD, the power of compounding works by growing your wealth exponentially.
So instead of choosing one, why not both.
Isn’t it better to have a lot of your savings “compounded” than a little? Let the little that you have first pile up and then let “compounding” work its magic.