A fixed deposit is a safe investment option that many investors choose in order to enjoy stable returns. The way a fixed deposit works is simple. You deposit a lump sum in a bank or a non-banking financial company. Interest is calculated on the amount you deposit. This interest can either be invested back into the FD through the reinvestment option, or it can be paid out to you periodically, on a monthly, quarterly, semi-annual or annual basis.

But how is this interest calculated, in the first place? If that’s what you want to know, let’s take a look at the details.

How do banks calculate FD interest?

To understand how banks calculate interest on your FD, let’s take up an example. Consider these particulars:

• Initial investment amount = Rs. 10,000
• Rate of interest = 6% per annum
• Investment tenure = 2 years

In this case, this is how the bank will calculate interest for year 1 and year 2 if you choose the reinvestment option.

Interest for year 1:

= Rs. 10,000 x 6%

= Rs. 600

Interest for year 2:

= Rs. 10,600 x 6%

= Rs. 636

If you invest for a longer period, this interest of Rs. 636 is added back to the principal (Rs. 10,600), and interest for the next year will be calculated on that cumulative amount of Rs. 11,236.

On the other hand, if you choose the payout option, your interest will not be added back to the principal. Instead, it will be paid out to you. So, you will receive Rs. 600 in year 1 and in year 2. The principal will continue to remain Rs. 10,600.

The formula for calculating interest on your FD

Here is the formula if you wish to figure out how much interest you will get on your FD investment.

Where,

P = Principal, which is the initial amount of investment

R = The rate of FD interest

N = Compounding frequency such as annual, half-yearly, quarterly or monthly

T = Tenure of the FD

You just need to subtract the principal from the maturity amount to get the interest component.

Now, doing simple math for a short investment tenure, with easy numbers like Rs. 10,000 is not a tough task. But banks deal with large sums of money in their FDs, and the tenures vary from one deposit account to another. Calculating the interest can be cumbersome. Hence most institutions which offer FDs will also provide you a FD Calculator so that you can understand how much you stand to gain from investing in a Fixed Deposit

A much easier way to calculate FD interest

Banks also offer online tools to help individuals easily compute the interest they will receive from their FD. Known as the FD calculator, this online tool helps you understand how your principal will grow over the investment tenure.

You can quickly make use of an FD calculator online before you invest in a deposit. An online FD calculator is fairly easy to use. You just need to input information like the amount you will invest, the rate of interest, the frequency of compounding, and the tenure.  The calculator will then show you the maturity amount. And the interest is simply the difference between the principal and the maturity amount.

Conclusion

You can also make use of the online FD calculator on Finserv MARKETS to get a better idea of how much you will earn. While you’re at it, you could also browse through the numerous FD options available on Finserv MARKETS to make the right investment choice.