Investing in fixed deposits is an excellent way to boost savings. A fixed deposit is a convenient means of investing. Such deposits offer safety and guarantee high returns. The reason behind the term fixed deposit is the tenure of these investments is fixed. The following article explains how to value a fixed deposit.
The value of a fixed deposit varies from bank to bank. But once the investment towards this account is made, it is locked-in for the entire duration. This means that fixed deposits are not liquid. Individuals cannot withdraw their money from this account through ATM, net banking, debit card, UPI, etc.
To withdraw the amount from a deposit, one will have to break the FD permanently. And breaking the FD before its maturity is not efficient. There are penalties associated with it. But have you ever wondered how the fixed deposits are valued? I am sure most of the investors must be having the same question in their minds. As investors, we must know what happens to our money when it is invested in a fixed deposit account.
This article aims to enrich the reader about the valuation of fixed deposits. How to value a fixed deposit? What is a fixed deposit calculator? How to use a fixed deposit calculator? What is the significance of a fixed deposit calculator?
The benefits of using a fixed deposit calculator. And the method used for the calculation of the rate of interest on the fixed deposits will be discussed. To conclude, some frequently asked questions will also be answered. So, let’s get started.
How To Value A Fixed Deposit?
To value a fixed deposit, a mathematical formula is used. This method can be used to value any asset. But before checking the value, individuals must confirm the liability factor of the valuation. The mathematical formula used for the valuation of the fixed deposit is given by:
Where V=present value of the fixed deposit.
n= holding time.
r= discounting factor.
I= interest earned at the end of each period.
P= principal amount.
Now, let’s try and apply this formula by considering an example.
- Principal amount deposited: Rs.10,00,000
- Interest rate: 9.00% per annum
- Term of investment: 5 years
- Inflation rate: 6.5% per annum
Besides the values mentioned above, we all have the discounting factor and the inflation rate. The inflation rate is used for debt for based investments. For investments based on equity, the ‘expected returns’ or ‘weighted average cost of capital’ is used. It is important to consider the inflation rate. As the investment grows at the rate of interest, it is also devalued at the rate of inflation. Thus, the net growth of the deposits is usually less than the interest rate offered.
Calculate The Present Value Of The Fixed Deposits
While calculating the present value of the FDs, we will consider two cases:
1. The interest is paid at the end of every year
Here, let us assume the discounting factor r=6.5%. Now with the interest payable at every year-end, the cash flow for a tenure of 5 years will be as follows
As it is evident from the given table, initially a principal amount of Rs.10 lakh is deposited in the account. In the subsequent years, the interest is credited to the account. The interest earned is at the rate of 9% per annum. In the fifth year, when the term ends the principal amount is returned to the investors. Now, we have a brief idea of how fixed deposits help us earn high returns. But, let us look into what is the actual price we are likely to receive by using the mathematical formula.
After calculating the sum of the net returns, the present amount of these deposits after 5 years comes up to only Rs.1,03,891. There is a drop in the present value of returns because of the inflation rate. This is the net extra cash the investor is likely to earn after 5 years in the fixed deposits. Now, let us go through the working of the fixed deposits where the interest is paid at the maturity of the deposits.
2. Interest is paid at the end of 5 years
In case let us assume the same inflation rate @6.5%. What will be the returns generated at the end of 5 years? Let’s find out.
According to this mode of payment, the interest is calculated only after 5 years. Once the interest is calculated, this amount together with the principal amount is returned to the investors. But this is calculated without considering the inflation rate. So, let’s calculate the present value of this investment.
Thus, the net returns earned by the investor, in this case, will be -2,04,430. This is a huge drop due to inflation. The impact of inflation is hazardous to the finances of every investor. This implies that FD are not a good investment option for long term investments. For such long durations, investors should opt for equity investment options or balanced schemes.
What Is A Fixed Deposit Calculator?
A fixed deposit calculator is an instrument that is used to predict the estimate at maturity. This tool can enable investors to get a brief idea of their returns at the end of the term. It also helps to calculate the interest earned in fixed deposits. To achieve this the principal amount, the interest rate, and the tenure are used.
How To Use The FD Calculator?
Various online calculators are available and they are easy to use.
The procedure to use these is simple.
- First, enter the principal amount to be deposited in the fixed deposit amount.
- Then enter the interest rate offered by the bank.
- Lastly, enter the tenure for the activation of the fixed deposit.
- After filling in these details, click on the calculate button. This will predict the estimated maturity value. The total interest earned will also be mentioned in the column next to this.
What Is The Significance Of Using A Fixed Deposit Calculator?
Investing money can either benefit an investor or add to his losses. It is never certain. Thus, to assist the investment in fixed deposits, we have FD calculators. No investor will want to invest in any financial scheme which does not bring in any returns. It is always about reducing the risks as much as possible and enhancing the returns to the extreme.
Investment in FD is secure as it does not revolve around the market. But, it is bounded by certain constraints. Long-term investments in FD may not be entirely good for the financial health of an investor.
Therefore, one must always rely on the online FD calculators as they give a clear estimate of the returns after maturity. These calculators also assist in comparing the various types of FDs offered by different banks and NBFCs. This enables the investors to avail of the right deal and maximizes their returns.
Benefits Of Using Fixed Deposits Calculator
There are several benefits of using online calculators.
Some of them are listed as follows.
- There will be no errors generated in the calculation. Their results are always accurate. Since these calculators are automatic.
- The calculator will process the zeroing of complex calculations. This may be due to different tenures, interest rates, and principal amounts.
- The online calculators are free of cost. They can be used by investors multiple times. The returns can be checked for different combinations of tenures, interest rates, and principal amounts.
How To Calculate The Interest Rate On Fixed Deposits?
There are two methods for the calculation of interest rate. These are simple interest and compound interest. In simple interest, the interest rate is pre-defined. This means that the interest earned on any investment is already pre-defined for a specified duration. Compound interest is defined as the interest earned on the principal amount and the interest earned.
Simple Interest Formula:
Where P= Principal amount.
R= rate of interest (in %)
T= tenure of the investment.
Now suppose an investor has invested an amount of Rs.1,00,000 for a tenure of 2 years at an interest of 10% per annum. Then after 2 years, the returns will be
SI= 1,00,000*10*2/100 =Rs. 20,000
Thus, the amount that he will receive at maturity is Rs. 1,00,000 + Rs. 20,000 = Rs.1,20,000
Compound Interest Formula:
Where A= amount at maturity
P= principal amount.
r= interest rate.
n= number of compounding in a year.
t= number of years.
Now suppose an investor has invested Rs.1 lakh for a tenure of 2 years at an interest of 10%. The interest will be quarterly compounded. Then at the end of 2 years, the returns will be
A= 1,00,000 = Rs. 1,21,840
1. What is a fixed deposit calculator?
A fixed deposit calculator is an online device which helps the investors to calculate their returns after the maturity of the fixed deposits. The inputs for this calculator are the term of investment, the interest rate, and the principal amount.
2. Which method is used to calculate interest on fixed deposits?
For fixed deposits with a tenure of 6 months or less than that the simple interest formula is used. For fixed deposits with a duration of more than 6 months, the compound interest formula is used.
3. Are the fixed deposit calculators available online free to use?
Yes, the calculators available online are free to use.
4. The interest rate on fixed deposits is taxable?
Yes, the interest rate offered on fixed deposits is taxable. But several tax deductions can be availed by the investors. Under Section 80C of the Income Tax Act, a deduction of up to Rs.1.5 lakh can be availed by the investors.
5. Do senior citizens have a different calculator to check the amount at maturity?
No, the senior citizens do not have a separate calculator. The calculator is universal. But the inputs like principal amount, tenure, and the interest rate will differ.
6. Are there different calculators for different fixed deposit schemes?
No, the calculator is the same for all the fixed deposit schemes.
7. How fast does the calculator work?
The online calculators are as fast as any other normal calculator. They provide the results within a few seconds.
It is the responsibility of every investor to know the whereabouts of his investments. He should have a basic understanding of how interest is calculated. He should also be aware of how it is affected by inflation. Inflation is the biggest enemy of every investor. But FD are not suitable tools for long-term investment. The investors may end up with negative returns if the inflation rate is higher than the interest rate in the long run and now you know the value of FDs. We know how to estimate our future returns for various tenures, investors will be in a better position before making any investments in the future. The online calculators offer great respite as they save time and effort. Otherwise, investors would have to perform cumbersome calculations manually to check their returns. So that’s all, I hope the readers will make use of FD calculators before making any investment decisions.