what is a fixed deposit? Is it the best investment option?

fixed deposit or FD is one of the oldest and most used financial investment instruments. it's the safest way to invest your idle money and turn it into guaranteed returns. as the name suggests, fixed deposits have a fixed rate of interest and do not fluctuate with market volatility. 'guaranteed returns with negligible risk' - is what makes fixed deposits the most preferred investment tool among masses. 

you can open a fixed deposit account with any bank or non-banking financial company (NBFC). you can visit the official website of the selected bank or the nearest branch office to submit your FD account form and related documents. following are some of the common documents required to open a fixed deposit account:

• ID proof
• address proof
• PAN card or Form 60/61
• picture of applicant and nominee
• those who do not have taxable income can submit Form 15G or 15H

why should you invest in fixed deposits?

here are some of the key features of fixed deposit (FD) that makes it one of the safest and best investment options available in the market:

assured returns: the interest on an FD account is calculated based on a fixed rate of interest. the fixed deposit rate of interest selected at the time of booking the FD does not vary with fluctuations in the financial market. hence, you can use a fixed deposit calculator to easily estimate the amount of money you will receive at maturity of your fixed deposit account. you can use a free online tool - CRED fixed deposit calculator - to calculate the FD maturity sum. 

FD gives benefits of compounding interest: you can use fixed deposits to earn interest on interest, and get higher returns and faster multiplication of the amount invested. 

can start with a small amount: it's a great tool for beginners who do not want to invest big amounts or take risks but want to inculcate an investment habit. fixed deposit accounts can be opened with as low as ₹500.

flexible tenure: you can open a fixed deposit account for as short as 7 days to 10 year, and in some cases 20 years as well. 

liquidity: in case of immediate financial requirement, you can choose to make a premature withdrawal out of your fixed deposit account. although, the bank will deduct some interest in the missed duration. however, the premature withdrawal option gives you the benefit of liquidity in times of emergencies.

deposit insurance of ₹5 lakh: this is another reason why FDs are considered the safest investment. in case the bank defaults, Deposit Insurance and Credit Guarantee Corporation (DICGC) provides compensation of ₹5 lakh to the depositor who has FD in a registered bank in India. 

best investment tool for senior citizens: fixed deposit is the best investment tool for senior citizens, or for those who are above 60 years of age. for senior citizens, banks and NBFCs offer preferential (additional) FD interest rates above the standard fixed deposit interest rates. the difference can range from 0.25% – 0.65% (approximately). currently, some of the banks in India offer FD rates to senior citizens at up to 8.00%.

claim income tax deductions: as per the income tax laws, you can claim income tax deductions on investing in a fixed deposit if the tenure is 5 years or more. under Section 80C of the Income-Tax Act, investors can claim income tax deduction for investments up to ₹1.5 lakh in a financial year by investing in tax-saving FDs.

how does an FD account function?

once you open a fixed deposit account, you can deposit your money for a time period ranging from 7 days to up to 10 years or 20 years in some cases. you can think of it as lending your money to a bank or an NBFC for a certain tenure. when you open a FD account, the bank or NBFC, guarantees to return the invested money at the end of the investment period, and pays you the accrued interest. the accrued interest is directly transferred to the account of the deposit holder. the fixed deposit interest payment frequency can be monthly, quarterly, half-yearly or yearly. 

the fixed deposit interest rate varies from bank to bank and also depends on the tenure or maturity period of the FD. it's highly recommended that you should compare and calculate the fixed deposit interest rate offered by various financial institutions to make a smart choice. 

there are two ways to calculate interest on fixed deposits - cumulative FDs and non-cumulative FDs. 

in a cumulative FD account, interest and the principal amount is paid at the maturity period. the accrued interest is reinvested every year, hence, you will not receive regular interest payouts, instead, the bank will pay a lump sum amount at the end of the FD tenure.

if you want to receive interest on FD at regular intervals, open a non-cumulative FD account. in this type of FD account, you can choose to receive FD interest payments monthly, quarterly, half-yearly, or annually. it's great for people who want a regular stream of income. however, on the downside, you will lose out on earning interest on interest.

how to calculate interest on a fixed deposit?

the interest earned on fixed deposits depends upon - the sum invested, the rate of interest being offered, and the tenure of the investment. here's a simple formula to calculate interest on fixed deposit 

interest on fixed deposit = principal amount invested x interest rate x (tenure/12 months)

alternatively, you can use CRED fixed deposit calculator to find out the maturity sum, tenure, interest earned on the investment.