If you are planning on making a Fixed Deposit, then read on to learn about 5 important points to keep in mind when calculating the maturity value
In order to secure your financial future, it is important to learn how to manage, invest, and save your hard-earned money. People tend to hand over these responsibilities either to a chartered accountant or simply accept the figures that banks present to them. This saves you a lot of stress in the short term, but it could have major negative consequences in the future.
Know what is fixed deposit and how can it help in your life, Fixed Deposits are the easiest way to save money. It is an investment vehicle in which you put in a sum of money for a fixed period of time. As this instrument is popular amongst the masses, people usually opt for it without doing any research or calculations. This can actually lead to financial losses in the long run.
For example, if there is a calculation error by the bank, you will end up receiving less than the actual maturity amount. What’s worse? You won’t even know it! So, why not take a few easy steps to make your investments risk-free. There are many factors that affect the money you put in FDs. Therefore, it is important to learn how to do the correct calculations so that you know the actual worth of your investment.
Here is a look at five things you should remember when calculating your Fixed Deposit maturity value:
- Is Simple Interest the Right Way to Go
Most people who are new to the world of finance use the simple interest method to calculate the maturity value of their Fixed Deposit. Though this seems like the easiest and the most obvious way to do it, this method will give you a figure that is a lot lesser than your actual maturity value. This is because financial institutions rarely ever use the Simple Interest formula to calculate MVs. This method only takes into account the principal amount when calculating the interest generated. It does not factor in the increase in the total amount (principal + interest) as time progresses.
Here is an example that will help you better understand the methodology:
If you have an FD for Rs.1 lakh at an interest rate of 5% per annum, where interest is calculated annually for a period of two years, then the amount of interest you will earn will be:
Year 1: Rs.1,00,000 X 5% = Rs.5,000
Year 2: Rs.1,00,000 X 5% = Rs.5,000
Total interest earned at the end of 2 years = Rs.5,000 x 2 = Rs.10,000
The Maturity Value= Rs.1,00,000 + Rs.10,000 = Rs.1,10,000
Banks use an alternative method to calculate your FD’s maturity value, which we will have a look at below. Remember that the first and foremost thing to bear in mind when calculating the maturity value of Fixed Deposits is to never use the simple interest formula.
- Understanding Compound Interest
It is the compound interest method that is used to calculate the correct maturity value of a Fixed Deposit. Unlike the simple interest equation, interest on FD is calculated as well as compounded annually. This simply means that the interest earned is added to the principal amount for subsequent annual interest calculations.
Now let us take the previous example and calculate the MV using compound interest:
Year 1: Rs.1,00,000 X 5% = Rs.5,000
Year 2: (Rs.1,00,000 + Rs.5,000) x 10% = Rs.1,05,000 X 10% = Rs.10,500
Total interest earned at the end of 2 years = Rs.15,500
Maturity Value= Rs.1,00,000 + Rs.15,500 = Rs.1,15,500
You will notice that the maturity value is higher in the second case. So, when you starting doing calculations to arrive at the correct MV, always remember to use the compound interest methodology.
- Timing of Compounding
The basic compound interest formula is:
Maturity value = P*(1+R/100)^N,
P is the principal amount
R is the rate of interest charged per annum
N is the time duration in years
Despite using this formula to calculate the MV, you may not arrive at the same figure as your bank. This is because of one small factor, the timing of the compounding. In the standard formula, the compounding of the interest happens on an annual basis. However, most Indian banks compound on a quarterly basis (3 months). This actually helps increases your returns even further!
So, when calculating the MV, factor in quarterly compounding. In the above formula, R should be altered to R X 4 and N should be N/4. So, the final formula is:
- Tax Saving Fixed Deposit
If you are planning to make a Fixed Deposit for at least 5 years, then you may want to opt for a tax saving FD. This investment instrument is eligible for tax deduction under section 80C of the Indian Income Tax Act, 1961, with a maximum investment amount of Rs.1.5 lakhs in a financial year. This basically means that your MV will be higher for taxing saving FDs as compared to normal FDs. So, when you are calculating your maturity value for a 5-year FD, remember to keep the tax deduction in mind.
- Fixed Deposit Calculator
It is definitely a good idea to do your MV calculations on pen and paper. However, to ensure that you have made no mistakes, use Fixed Deposit calculators to verify your numbers. The MV amounts of the bank, your calculations, and the calculator should all be the same.
From the four points stated above, you will have noticed that when calculating your FD maturity value there are quite a few factors to take into consideration. In order to leave absolutely no room for error, remember to use these online calculators. There are dozens available on the internet, and they are easy to use. All you have to do is input a few basic details, like the principal amount, tenure, and interest rate. The correct MV will be displayed within seconds. Cross checking figures is a good way to go when making decisions about your financial future.
Now that you know the five most important things to take into account when calculating maturity values of Fixed Deposits, you can confidently do your own calculations and take your financial planning into your own hands.