FD vs. NSC: It's not the interest rate, but the method of interest calculation that determines the profit..

Often, when investing, people first look at the interest rate. They invest their money in the scheme that offers the highest interest rate. But the reality is that profit is not determined solely by the interest rate. The real game is in the method of compounding the interest. Sometimes, a scheme with a lower interest rate can give a higher return. Post Office FDs and NSCs are the best examples of this. Let's understand the entire calculation in simple terms.

Post Office FD Vs NSC: What's the difference?

A 5-year Post Office FD offers an interest rate of 7.5%.
While NSC (National Savings Certificate) offers an interest rate of 7.7%.

At first glance, it seems that NSC is better, but the return figures tell a different story.

Understand the complete calculation with an example:
Let's say you invest ₹5,00,000 in a Post Office FD. You invest the same amount in an NSC as well.

How much return will you get in NSC?
Based on a 7.7% interest rate, after 5 years in NSC:
Total interest earned: ₹2,24,517.
Maturity amount: ₹7,24,517.
How much return will you get in the Post Office FD?
Based on a 7.5% interest rate, after 5 years in an FD:
Total interest earned: ₹2,24,974.
Maturity amount: ₹7,24,974.
The difference here is only ₹457, but the question is, how is the FD giving a higher return despite a lower interest rate?

How is interest calculated in NSC?
In NSC, interest is compounded annually. This means that every year, the principal amount and the previous year's interest are added together to calculate the next year's interest.

For example:

First year: 7.7% on ₹5,00,000 = ₹38,500 interest.
Second year: 7.7% on ₹5,38,500 = ₹41,464 interest.
Similarly, interest is added once every year. Interest is applied a total of 5 times over 5 years, and the maturity amount becomes ₹7,24,517.

How is interest calculated in a Post Office FD?

In a Post Office FD, interest is paid annually, but it is calculated quarterly.

The 7.5% interest is divided into 4 parts.
7.5 ÷ 4 = 1.875%, meaning 1.875% interest is applied every three months.
For example, in the first three months, 1.875% on ₹5,00,000 = ₹9,375.

The amount becomes ₹5,09,375. In the next three months, interest will be applied again on this increased amount.

In this way, interest is added 4 times a year and 20 times over 5 years. This is why the maturity amount of the FD after 5 years becomes ₹7,24,974, which is slightly more than the NSC.

What if the interest rates for FD and NSC were the same?
Let's say the FD also offered 7.7% interest. Then, after 5 years, the maturity amount of the FD would be ₹7,32,124. This means that due to the difference in compounding, the profit would be approximately ₹7,607 more. This proves that the method of interest calculation is more important than the interest rate itself.

Both offer tax benefits.
In both Post Office FDs (5 years) and NSCs, the investment is secure, and tax exemption is available under Section 80C of the Income Tax Act.

Disclaimer: This content has been sourced and edited from Zee Business. While we have made modifications for clarity and presentation, the original content belongs to its respective authors and website. We do not claim ownership of the content.