FD Vs NSC: Not the Interest Rate, but the Method of Interest Calculation Determines the Profit! Understand the Complete Math Before Investing
Both Post Office FDs and NSCs are safe investment options. The interest rate on NSC is slightly higher than that of a Post Office FD, but the FD still yields a slightly better return. Understanding interest calculation and compounding is crucial before investing.
Often, when investing, people first look at the interest rate. They invest their money in the scheme that offers the highest interest. But the reality is that profit is not determined solely by the interest rate. The real game is played by the method of interest calculation, i.e., compounding. 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 complete calculation in simple terms.
Post Office FD Vs NSC: What is 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 math with an example
Suppose you invest ₹5,00,000 in a Post Office FD. If you invest the same amount in NSC:
How much return will you get in NSC?
At an interest rate of 7.7%, after 5 years in NSC:
Total interest earned: ₹2,24,517.
Maturity amount: ₹7,24,517.
How much return will you get in Post Office FD?
At an interest rate of 7.5%, after 5 years in 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% interest on 5,00,000 = 38,500 rupees.
Second year: 7.7% interest on 5,38,500 = 41,464 rupees.
Similarly, interest is added once every year. In 5 years, interest is applied a total of 5 times, and the maturity amount becomes 7,24,517 rupees.
How is interest calculated in a Post Office FD?
In a Post Office FD, interest is paid annually, but it is calculated on a quarterly basis.
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 rupees.
The amount becomes 5,09,375 rupees. In the next three months, interest will be applied again on this increased amount.
In this way, interest is added 4 times in a year and 20 times in 5 years. This is why the maturity amount of the FD after 5 years becomes 7,24,974 rupees, which is slightly more than the NSC.
What if the interest rate 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 rupees. This means that due to the difference in compounding, the profit would be approximately 7,607 rupees more. This proves that the method of compounding is more important than the interest rate.
Both offer tax benefits
In both Post Office FD (5 years) and NSC, the investment is secure and tax exemption is available under Section 80C of the Income Tax Act.
FAQs
Q1. Which gives a higher return, FD or NSC?
The return is determined not by the interest rate, but by the compounding method. In many cases, the return from an FD can be higher than that of an NSC.
Q2. How often is interest compounded in NSC?
Interest in NSC is compounded annually.
Q3. How is interest compounded in Post Office FD?
Interest in FD is compounded quarterly, but the payment is made annually.
Q4. Do both FD and NSC offer tax benefits?
Yes, both offer tax benefits under Section 80C.
Q5. What should you pay most attention to before investing?
Along with the interest rate, you should definitely check whether the interest is compounded annually or quarterly.
