Cumulative Fixed Deposit vs Non-cumulative Fixed Deposit

One of the basic pillars of finance is the power of compounding, which is all about making money work harder and accumulating interest and enhancing the principal. We normally talk about deposits as non-cumulative fixed deposits wherein the interest is earned each year only on the base principal. So if you base principal is Rs1 lakh, you earn interest on this amount. However, if you opt for a cumulative deposit or a cumulative FD, you get the added power of compounding. Each year you earn interest on principal plus accumulated interest.

When we talk about a fixed deposit or the fixed deposit rates of interest, we also need to work out if the deposit is a cumulative fixed deposit or a non-cumulative fixed deposit. Why is this distinction important? You can end up earning higher effective returns on a cumulative FD since the interest is being compounded and is becoming your principal each subsequent year. That is the core difference between cumulative and non-cumulative FD.

What is a Cumulative Fixed Deposit? 

Cumulative refers to accumulation. Similarly, a cumulative fixed deposit is one that accrues interest until it is withdrawn at the end of the maturity period. One year's or one cycle's worth of interest is reinvested or added to the prior principle, raising the principal. This in turn increases interest. Here, compounding's power is used to its fullest potential. You get the maturity amount, which is equal to the sum of your initial deposit and accrued interest, when your FD matures.

For people who are not dependent on interest income, this sort of FD is appropriate. These individuals may be those with steady incomes or those running profitable enterprises. If you wish to save a certain amount for the future and don't mind forgoing monthly interest payments into your account, think about a cumulative fixed deposit.

What is a Non-Cumulative Fixed Deposit?

With a non-cumulative fixed deposit, the depositor receives interest payments on a regular basis. The time between interest payments might range from monthly to quarterly and, in rare cases, semi-annually. Due to the fact that the interest is not withheld by the bank, this sort of FD provides investors with a consistent payout. Due to improperly exploiting the potential of compounding, it yields less interest than cumulative FD.

For retirees, independent contractors, and stay-at-home moms who want monthly income from their investments, non-cumulative FD works well.  

Difference between Cumulative and Non-Cumulative FD

The fundamental distinctions between cumulative and non-cumulative FD are as follows:

Definition

In a cumulative fixed deposit, interest builds up and is paid out together with the principle at maturity. While in a non-cumulative FD, the depositor can choose the frequency of interest payments.

Flow of income from a fixed deposit

A cumulative FD has a fixed term during which the depositor receives no income. At the conclusion of the scheme's duration, the principal and accumulated interest are paid in one single payment. Non-cumulative fixed deposits, on the other hand, provide depositors with a consistent stream of income. One may choose how frequently interest is paid and enjoy reliable income during the deposit term. 

Reinvestment

The interest that is generated is put back into a cumulative deposit plan. The depositors so receive interest on interest. Consequently, compared to a non-cumulative FD, this results in greater and more meaningful returns. A non-cumulative FD, on the other hand, does not allow for interest reinvestment. Regular periods are established for interest payments. Additionally, compared to the cumulative FD option, the overall interest rate is a little lower.

Payout of Interest on a Fixed Deposit

The main distinction between cumulative and non-cumulative FDs is this. The interest on a cumulative FD is due at maturity. While with non-cumulative FDs, the investor can choose how much interest they want to receive. In a cumulative system, interest is reinvested into the overall plan. As a result, interest is only paid upon maturity. Every quarter or every year, the interest compounds. 

Suitability

A cumulative option offers higher returns and compound interest than a non-cumulative fixed deposit. Because the maturity time ranges between 6 months and 5 years, a cumulative fixed deposit is a suitable choice for a long-term investment for persons who wish to receive a guaranteed sum at the end of their investment duration. Because some investors desire a monthly income, there is also the option of a cumulative fixed deposit. A money multiplier is an interesting alternative name for a cumulative fixed deposit. Therefore, those who are working or have a consistent income should choose cumulative fixed deposits. 

A non-cumulative fixed deposit is an alternative for investors who prefer a steady source of income from their assets. The non-cumulative fixed deposit plan is suitable for retirees, independent contractors, stay-at-home moms, etc. since they may count on getting consistent interest payments from their assets.

Cumulative FD versus non-cumulative FD (Understanding the gist)

To understand how the cumulative FD differs from the non-cumulative FD, look at some basic points here. 

1) Let us start with the conceptual difference. A cumulative fixed deposit (FD) accumulates the interest amount until maturity. The interest that is earned every year or quarter is added to the principal amount and is paid in total at the time of maturity. On the other hand, the non-cumulative fixed deposit pays the interest regularly to the investor and the calculation of interest is always on the base principal. Interest pay-out can be monthly, quarterly, half-yearly or yearly.

2) Who should opt for these products and under what circumstances. A cumulative FD is ideal for investors who are not depending on income from FDs to run their expenses or those who have idle funds lying with them. Here, cumulative FD offers a higher yield due to compounding. However, if you are looking for regular income to meet routine expenses, then a non-cumulative fixed deposit is a much better choice for you.

3) In a cumulative FD, there is no intermittent payment of interest. Instead, the notional interest accrued each period is added to the principal and in the next round of interest calculation the interest is calculated on the enhanced principal. This cycle goes on and accumulates more money and pays out at maturity. In a non-cumulative FD, the regular interest is paid out either quarterly, half yearly or annually and at maturity only the principal amount is paid back to the investor.

4) The cumulative FD, as a result, does away with the reinvestment risk. In a non-cumulative FD, there is always the concern that the intermittent interest received may not be invested productively The cumulative FD simplifies the task for you by accumulating the principal and interest in a systematic manner. Hence effective yield is much higher in a cumulative FD as compared to a non-cumulative FD.

5) They also differ in terms of maturity. Typically, the cumulative FD has a tenure between 6 months and 5 years. However, if you look at the traditional non-cumulative FDs in India, the tenure ranges from as low as 7 days to as high as 10 years, so there is a complete array of choices. Non-cumulative FDs are still the preferred product where there is the need for regular income to meet routine needs. 

Here is a quick and simple illustration to understand the difference. For both FDs, the principal is Rs100,000, interest is 8% and tenure is 6 years. 

The cumulative FD has created more final amount due to the compounding benefit. That is the basic difference.

Conclusion 

Your decision will determine which of the two interest payment options you choose. Non-cumulative FD is the best option if your goal is to supplement your current income or to set aside money for a pension after retirement. However, if your goal is to exponentially increase your current savings rather than to add more, you should definitely choose the cumulative option. It is essential to speak with a financial expert like blinkX to choose the best FD type depending on one’s unique situation and financial goal. 

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