Most investors desiring stability prefer investing in a Fixed Deposit (FD) because it is one of the safest investment instruments. It lets you invest a specific amount of money for a fixed period safely and securely. It offers an assured interest rate depending on the FD amount and selected tenure.
You must learn how much interest you can earn from an FD before investing in it. For this calculation, you must know how FDs work, the types of Fixed Deposit interest, and the formula to calculate Fixed Deposit interest.
How does Fixed Deposit work?
To create a Fixed Deposit, you must only make a one-time deposit. The sum of money you deposit is called the principal. You earn interest on the deposited amount for a fixed period. The interest rate is pre-determined and varies based on different factors. Any individual holding a bank account can open an FD. The minimum deposit amount is ₹ 1,000, while the minimum tenure is seven days.
Upon maturity of your FD, you receive the principal amount and the interest. You receive interest earnings periodically if the payout frequency is monthly, quarterly, semi-annually, or annually.
Types of Fixed Deposit interests
Fixed Deposit interest is calculated in two ways: simple interest and compound interest. Banks can use both methods based on the deposit amount and the fixed tenure.
1. Simple interest
Simple interest is calculated on the principal amount only. The interest is paid out regularly, such as monthly, quarterly, annually, etc. The interest amount does not change throughout the tenure.
How to calculate the FD interest: formula for simple interest
Example:
- Principal amount (P) = ₹ 2,00,000
- Interest rate (R) = 8% per annum
- Tenure (T) = 2 years
Simple Interest (SI) = (P * R * T) / 100
SI = (200000 * 8 * 2) / 100 = ₹ 32,000
Thus, you will earn an interest payout of ₹ 32,000 if you start a Fixed Deposit of ₹ 2,00,000 at an 8% simple interest rate for a 2-year tenure.
2. Compound interest
Compound interest is calculated on both the principal amount and the interest. It provides higher returns than simple interest. Compounding can be done at different frequencies, such as monthly, quarterly, semi-annually, and annually.
Example:
- Principal Amount (P) = ₹ 2,00,000
- Interest Rate (R) = 8% per annum
- Tenure (T) = 2 years
How to calculate the FD interest: Formula for compound interest
A = P(1 + (R/N))^(N*T), where:
- A stands for the total amount
- P for the principal amount
- R for interest rate
- N for frequency of compounding interest annually
- T for tenure
So, assuming interest is compounded annually, the total amount for the above example is:
A = 200000 * (1 + (0.08)/1)) ^(1*2)
A = 200000 * (1.08)^2 = ₹ 2,33,280
Compound interest (CI) is the difference between the total amount (A) and the principal amount (P):
CI = A – P
CI = 2,33,280 – 2,00,000 = ₹ 33,280
Thus, the interest earnings for a Fixed Deposit of ₹ 2,00,000 at a compound interest rate of 8% per annum for 2 years are ₹ 33,280.
Summing up
Calculating Fixed Deposit returns is tedious, especially when there are large numbers to deal with. However, if you know how Fixed Deposit is calculated, you can earn higher returns at the end of the investment tenure.
An online Fixed Deposit calculator can ease out calculations. It can help you instantly estimate the returns you can earn on different principal amounts deposited for different tenures at an interest rate pre-determined by the financial institution or bank.
