Cumulative vs Non Cumulative Fixed Deposit

In a fixed deposit, you invest a lump sum amount with a bank, post office or NBFC for a fixed period at a predetermined rate of interest. The tenure of an FD can vary from 7 days to 10 years. Fixed Deposits generally allow investors to make premature withdrawals, but some financial institutions may charge a penalty fee.

The interest paid out on the FD could be monthly, quarterly, half-yearly, or yearly to suit the investor’s needs. The FD’s tenure is a primary determining factor of the interest rate because with time the holding period risk increases thereby causing an increment in the interest rate. This in practice translates to a 7-day FD carrying a lower rate of interest than a year-long FD.

The word cumulative means to ‘increase by successive additions.’ In a cumulative fixed deposit, the interest earned on an FD is added back to the principal and reinvested. This means that you will not receive regular interest payouts in Cumulative Fixed Deposits.

Consequently, the next interest payment is calculated on the entire amount, including the principal and the reinvested interest. The reinvestment happens throughout the tenure, and a lump sum amount can be redeemed at maturity. The lump sum, hence, comprises both — the principal and the accumulated interest.

People who are not dependent on their investments for a regular income stream can opt to invest in a cumulative FD. So, salaried employees and people earning a stable income from their businesses may find cumulative FDs beneficial.

Other than this, if you want a lump sum amount to meet a future goal, you can consider investing in a cumulative FD.

In contrast to its counterpart, non-cumulative FDs regularly pay interest to the investors, either monthly, quarterly, half-yearly or annually. As a result, the returns on non-cumulative fixed deposits are not compounded and have a slightly lower effective interest rate.

People who do not have a regular income stream, such as freelancers, salespeople, retired persons, etc., could opt for a non-cumulative fixed deposit to stabilise their finances. Homemakers or stay-at-home parents can also invest their savings in a non-cumulative FD to create a regular income stream for themselves.

Meaning

A cumulative FD means a fixed deposit where the interest is accumulated and reinvested, and the investor receives a lump sum at maturity. A non-cumulative FD pays out interest at regular intervals, and the principal amount is redeemed at maturity.

Interest Payout

One of the key differences between cumulative and non-cumulative FD is how the interest on investment is paid out.

Let’s say you invest Rs. 1 lakh in a cumulative FD for a tenure of 5 years at an interest rate of 6.5%. Below is the table showing the annual interest calculation on the cumulative FD.

As you can see, if you invest in a cumulative FD, the interest at the end of year 1, which is Rs. 6500, is reinvested, and the principal for year 2 becomes Rs. 100000 + 6500 = Rs. 106500. At the end of 5 years, you get an amount of Rs. 137009. Of this, Rs. 37009 is your accumulated interest.

Alternatively, for a non-cumulative FD of Rs. 1 lakh with a tenure of 5 years and interest rate of 6.5% (annual interest payout), the table of returns will be:

As seen above, in a non-cumulative FD, the interest of Rs.6500 is paid out annually to the investor. The total interest amount is Rs. 32500, which happens to be lower than that of a cumulative fixed deposit.

Income Flow

As seen above, a cumulative FD holder does not receive any payment during the tenure of the FD, after which he receives a lump sum. However, a non-cumulative FD holder enjoys a regular income flow throughout the term of the deposit until maturity. You can also choose the interest payout frequency depending on your unique investment needs.

Reinvestment

The interest income, in the case of a cumulative FD, is reinvested into the scheme. As a result, the investor earns interest even on his accumulated interest. In non-cumulative FDs, however, the interest is paid out and the investor only earns interest on the principal they had initially deposited. Consequently, the total returns on a non-cumulative FD are slightly lower than a cumulative FD.

Suitability

Due to its regular income stream, a non-cumulative FD is ideal for someone without a stable income, such as artists, salespeople, freelancers, etc. A cumulative FD, on the other hand, is only suitable for someone who doesn’t depend on the FD for a regular income stream, such as salaried employees, people with stable business profits, etc.

Different people have different goals for financial investment. If your goal is to add-on to your existing regular income, then non-cumulative FD might serve your purpose. But, if you are looking to multiply your current savings at an exponential rate, you may consider the cumulative scheme.

You can choose to invest in either of the FDs, post conducting due diligence in accordance with your risk profile and financial goals.