On comparing safe saving schemes, few instruments offer the simplicity and security of a Fixed Deposit (FD). Among the various FD options available, the cumulative FD stands out as a powerful tool to grow your wealth over time.
It offers a unique advantage – the power of compounding interest. This means that your interest accumulates and compounds instead of staying the same all through the tenor. Since the interest you earn is reinvested or added to the principal, you can watch your savings grow exponentially.
Understanding Cumulative Fixed Deposits
It is a type of FD where you receive the interest amount only at the end of the maturity period. Here is how a cumulative FD works:
- The interest amount you earn is compounded annually
- Instead of paying the same amount of interest periodically, the interest amount is added to the principal amount
- For the subsequent year, the issuer computes interest on the new principal amount
- This process continues until the end of the tenor
Due to this, cumulative FD rates are generally higher than non-cumulative FDs offering periodic interest payouts. Thus, these are ideal investment options if you are looking for long-term savings options with guaranteed returns.
Compounding Benefits on Cumulative FDs
This type of fixed deposit acts as a low-risk wealth-building tool. It harnesses the incredible power of compounding interest in the following way:
- Cumulative FDs add the interest earned to the principal amount so your gains are reinvested
- This increased principal earns more interest in the next period, and the cycle continues
- The longer your money stays invested, the more the compounding effect works to increase the corpus
- This can lead to a significant difference in returns over the long term
- Due to the compounding effect, the maturity amount of this fixed deposit is significantly higher than a non-cumulative FD
- This type of FD can help you reach your financial goals faster due to the power of compounding
How to Maximise Returns with Cumulative FDs
These instruments offer a straightforward way to grow your savings through the power of compounding interest. You can opt for the following strategies to maximise your returns with a cumulative FD:
- Compare Issuers
Different banks and financial institutions offer varying interest rates on their cumulative FDs. Compare cumulative FD rates across multiple issuers to find the most competitive option.
Also, consider factors like the reputation of the institution and the ease of account opening. Choose one that allows you to open an FD with ease online for maximum convenience.
- Check Credit Ratings
It is crucial to look for the creditworthiness of the issuer when investing. A higher credit rating indicates a lower risk of default. Review the credit ratings of potential issuers to assess the safety of your investment.
- Select a Suitable Tenor
The maturity period of your cumulative FD significantly impacts your returns. Longer tenors typically come with higher interest rates. However, consider your financial goals and risk tolerance when choosing a tenor.
If you need liquidity in the short term, opt for a shorter tenor. For long-term wealth creation, a longer tenor can be more beneficial.
- Use an FD Calculator
An FD calculator is a valuable tool to estimate your potential returns. Input the principal amount, interest rate, and tenor to determine the maturity value.
You get to calculate FD rates at which you can earn higher interest payouts through the power of compounding. This helps you compare different FD options and make informed decisions.
Benefits of Investing in Cumulative FDs
These provide higher returns but come with a rigid tenor criterion. The following are some of the advantages you can enjoy by investing in a cumulative FD:
- Higher Interest
Since they reinvest the interest earned, these types of FDs provide higher returns compared to non-cumulative FDs. Over time, this can significantly boost your overall earnings compared to non-cumulative FDs.
- Simplicity
These fixed deposits are also known for their simple investment and earning process. Unlike other investment options, there is no need to worry about managing your investments or reinvesting interest payments. This makes it an ideal choice for you if you seek a hassle-free investment.
- Long-term Benefits
Cumulative FDs are particularly well-suited for you if you plan to achieve long-term financial goals. By locking in your investment for a specific period, you can benefit from the compounding effect over several years.
This makes them an excellent option for retirement, saving for a child’s education, or building a safe corpus for future use.
- Financial Discipline
Investing in a cumulative FD can foster financial discipline. Since the funds are locked in until maturity, you are less likely to withdraw the money prematurely. This helps you stay committed to your long-term financial objectives.
Before beginning your investment journey, determine if a cumulative FD is the right fit for your savings strategy. You can do this by carefully considering your financial goals, risk tolerance, and investment horizon.
While cumulative FDs offer the potential for significant growth through compounding, they also involve a lock-in period. Weigh the benefits against the limitations before making a decision.
