Often, while investing, people first look at the interest rate. They invest in schemes that promise high interest rates. But the reality is that profits are not determined by the interest rate alone. The real game lies in the method of interest accumulation i.e. compounding. Sometimes even low interest rate schemes can yield higher returns. Post Office FD and NSC are prime examples. Let’s take a look at the entire equation in simple terms.
Post Office FD vs NSC: What is the difference
A 5-year Post Office FD offers 7.5% interest. On the other hand, an NSC (National Savings Certificate) offers 7.7% interest. It seems that NSC is good, but the return figures tell a different story. Let’s see through an example. Suppose someone invests Rs. 500,000 in a Post Office FD. If someone invests the same amount in NSC, then:
How much return will be available in NSC –
Based on 7.7% interest rate
How much return will be available in NSC after 5 years
Total interest earned: 2,24,517 Maturity amount: 7,24,517
How much return will be available in Post Office FD
FD at 7.5% interest rate after 5 years.
Total interest earned: 2,24,974.
Maturity amount: 7,24,974.
The difference here is only 457 taka,
But the question is how is FD giving higher returns despite low interest rate!
Also read –FD Interest Rates: These 3 Public Sector Banks Change Rates in January
How is interest calculated in NSC
Interest in NSC increases annually. This means that each year the principal and the interest of the previous year are added to calculate the subsequent interest. Example: In the first year, 7.7% interest on Rs. 5,00,000 = Rs. 38,500. In the second year, 7.7% interest on Rs. 5,38,500 = Rs. 41,464. Similarly, the interest is compounded once every year. In 5 years, the interest is compounded 5 times, resulting in a maturity amount of Rs. 724,517.
How is interest compounded on Post Office FD
Interest on Post Office FD is paid annually, but is calculated quarterly. 7.5% interest is divided into 4 parts. 7.5 ÷ 4 = 1.875%, i.e. 1.875% interest is charged every three months. For example, 1.875% on 500,000 taka in the first three months = 9,375 taka. The amount becomes 509,375 taka. Interest will be charged again on this increased amount in the next three months.
Thus, the interest is compounded 4 times a year and 20 times in 5 years. Because of this, the maturity amount of an FD after 5 years becomes Rs. 724,974, which is slightly more than that of an NSC.
If the interest rates of FD and NSC were the same, let’s assume that FD would also earn 7.7% interest. Then, the maturity amount of FD after 5 years would be Rs. 732,124. This means that the profit will be about Rs. 7,607 more due to the difference in compounding. This proves that the method of interest collection is more important than the interest rate.
Both have tax benefits. Investment in Post Office FD (5 years) and NSC is safe and tax deductions are available under Section 80C of the Income Tax Act.