Planning for the future is the key to most financial issues. Planning is not just about finding the right investment but also taking the time to understand the right time to invest and the right time to withdraw your investment.
Be it equity-related instruments such as mutual funds or stocks or even fixed income instruments like fixed deposits.
If you follow the stock prices over a period of time in the context of news and performance specific to it, you will be better positioned to make a purchase at lower prices.
Similarly, if you wish to invest in a fixed deposit, understanding the role of central bank policy rates will give you a broader perspective on knowing if the rates are going to go up or not.
Otherwise, you will have to just wait for a sudden change in rates in your bank to really know the rates are going up or down and you might be caught unaware.
Compound Interest Rates Calculation
When you invest in a fixed deposit, you can look at the best or highest prevailing rates. FD Interest rates in 2019 have been falling and have been slashed by five times by large banks in India. This shows the excess of liquidity present and the chance for you to lock in any high rates in fixed deposits.
Banks calculate fixed deposit interest rates on a compounding basis. This means the second-period interest is calculated on the first-period interest and principal together and this continues till the end of maturity. This gives a higher return to the holder.
Banks compound on a quarterly basis and the underlying formula is as follows –
M = P (1 + r/4/100) ^ (4*n) and M = P (1 + r/25)4n
M = Maturity Amount
P = Principal/Deposit Amount
N = Compounded Interest Frequency
You can also utilise freely available online FD calculators for this. Herein the important aspect is the number of times compounding takes place i.e., n. Compounding can happen monthly, quarterly, half-yearly, or yearly basis.
Banks calculate FD interest rates on a quarterly compounding basis. So interest is calculated on the principal after three months of investment. The next interest calculation is done on the Principal + 1st quarter interest.
A quarterly compound interest schedule would work like this –
|r = 10%, n =4||Principal||10,000|
|YEAR 1||Quarter 1||250|
|YEAR 2||Quarter 1||256.4102539|
|YEAR 3||Quarter 1||256.4102564|
This will add up to Rs 13,448 after three years of compounding. A higher compounding of monthly interest would yield Rs. 13, 481 after three years. Thus, you can understand how compounding plays a multiplier effect on your investments.
Factors apart from Compounding
A high-interest rate is an important factor to consider when going for compounding. The company fixed deposits work on yearly compounding only but offer 1-2% higher rates than banks.
So, Rs 10,000 invested at 7% (compounded quarterly) in a bank will only yield Rs 12,387 but a company fixed deposit can earn Rs 12,719 (compounded yearly) as it will still give more return because the rates are higher.
Bajaj Finance fixed deposits are offering higher interest than average bank rates to the tune of 8.35% for new investments. With a total deposit book of 16000+ crores and 2,50,000+ customers, this is one of the topmost choices of investors across all age groups.