The Power of Compounding – a phrase commonly used when talking about Fixed Deposits (FDs). However, in India, many investors are still unaware of the benefits of compounding. In fact, the compounding effect is what makes FDs attractive. FD interest is generally calculated either via the simple interest method or compound interest method, depending on the tenure. 

For long-term FD investments, generally, banks use the compound interest method to calculate interest. This impacts your FD investment allowing your money grow substantially over time.In this article, we have debunked the concept of compound interest in Fixed Deposits so that you can understand how staying invested for the long-term may help you grow your wealth in a safe and secure way.

The Power of Compounding Simplified  

The compound interest calculation method takes into account both the principal amount and accumulated interest from previous periods. Unlike simple interest, where only the principal amount is considered, compound interest allows your money to grow exponentially over time. 

Imagine you invest ₹10,000 in a Digital Fixed Deposit with an annual interest rate of 6.9% for 5 years, compounded annually. Using the compound interest formula:

A = P (1 + r/n)^(nt), where A = maturity amount, P = principal amount, r = rate of interest (%), n = the number of times the interest is compounded per year (for FD, it’s usually compounded quarterly, so n= 4 years), t = time in years. 

A = 10,000(1 + 0.069/1)^(1*5) 

A ≈ 14,078 

With compound interest, your initial investment of ₹10,000 has grown to approximately ₹14,078. This growth is due to the power of compound interest, which allows your money to earn interest not only on the principal amount but also on the accumulated interest from previous years. 

Disclaimer: The above calculation is for illustration purposes only. Ujjivan SFB doesn’t take responsibility of the accuracy of the information. 

Understanding FD Compound Interest Calculation 

To understand how compound interest is calculated in FDs, let's break down the formula: 

A = P (1 + r/n)^(nt) 

Where: 

• A is the future value of the investment or loan including interest.
• P is the principal amount (initial investment).
• r is the annual interest rate (expressed as a decimal).
• n is the number of times interest is compounded per year.
• t is the number of years the money is invested.

By plugging in the appropriate values, you can calculate the future value of your investment. Most banks provide online calculators that simplify this process for you. However, manual calculations can be taxing and may leave room for errors. To calculate the interest and maturity amount quickly, use our Fixed Deposit ROI Calculator.

Benefits of Compound Interest in FDs 

The power of compound interest makes FDs an attractive investment option. Here are some key benefits:

1. Higher Returns and Faster Growth

With compound interest, your money grows faster over time compared to simple interest. That’s because your accumulated interest also earns interest till maturity, contributing to overall growth. This means that you can earn more from your initial investment. 

2. Long-Term Wealth Accumulation

The longer you keep your money in FD, the more the compound interest works in your favour. Over longer periods, small initial investments can grow significantly due to compounding.

3. Consistent Growth

FD interest rates remain fixed throughout the tenure ensuring consistent and predictable growth. Compounding enhances this, making the growth steady and reliable.

4. Reinvestment Options

Many banks offer an option to reinvest the maturity amount, where the compounded returns are added back to the principal. This may help investors enjoy higher returns in the long-term.

Simple Interest vs. Compound Interest: Sample Calculation 

Let's look at a sample calculation to understand the impact of compound interest on FDs:

• Investment: ₹50,000
• Interest Rate: 7% per annum
• Tenure: 5 years

Using the compound interest formula: 

A = 50,000 (1 + 0.07/1)^(1*5) 

A ≈ ₹69,069 

Let’s check how your returns would look like using the simple interest method:

Simple Interest calculation formula: (P x R x T)/100 = (50,000 x 0.07 x 5)/100 = 1750000/100 = 17,500.

The interest earned is ₹17,500. The maturity amount would be ₹67,500.

Now, check the difference between the maturity amount, it’s approximately ₹1,500! Now, that’s what you call the power of compounding. 

How to Maximise FD Compound Interest 

To make the most of compound interest in FDs, consider the following tips: 

1. Choose the Right Tenure

Longer tenures generally result in higher earnings from compound interest in fixed deposits. Assess your financial goals and select a tenure that aligns with your needs.

2. Compare Interest Rates

Different banks offer varying interest rates on FDs. To maximise your earnings from FD , compare the interest rates offered by different banks and choose the best option. Generally, small finance banks like Ujjivan SFB offer higher FD rates.

3. Reinvest Earnings

Instead of withdrawing the interest earned, consider reinvesting it into the FD. This strategy will further enhance your earnings, leveraging the power of compounding over time. 

4. Automate Investments

Set up automated deposits into your FD account regularly. This ensures consistent contributions and maximises the compounding potential.