Which is the time-tested, low-risk way to invest money for an individual? Fixed Deposits! At some places it’s called as Term Deposit. Choose whichever name catches your fancy but the point is that Fixed Deposits (going forward it will be addressed as FD in this article. Seriously, I’m too lazy to write that long term over and over again even though I choose to write such a long explanation!)..okay lost the rhythm. Let’s rewind!
The
point is that FDs are the most popular investment avenues among Indians and the
investment portfolio of most of us is skewed towards this option. The reason of
the high popularity can be attributed to the fact that we trust the banks/post
offices to do their jobs properly, not to run out of business and handover the
money on maturity (in many situations prematurely upon request) to us. J
Now!
Coming to the purpose of the article.
I was
planning to invest some amount of money for certain duration. However, I did
not want to wait for the bank to provide me the expected maturity amount. In
simple terms, I can directly multiply the interest rate with the principal
amount and the number of years. I am happy, calculator is also happy and I am
momentarily back to the simple interest sums I had to solve during school days!
The bank is something like a Santa Claus and it puts some amount greater than
the simple interest calculation one makes.
How
do banks reach such apparently absurd figures? I wanted to figure it out!
Algebra
and some general knowledge helped me to solve this bit. (Oh, I miss school! L )
Let’s
say, I have x amount to invest for n number of years. The interest rate page displayed in the bank or on the
bank’s website spells it out that girl you are not going to get more than y% per annum for this many years of investment. (x, y, n, (a+b)2 and what not..they are still so charming!)
Now,
banks are obliged to calculate the interest quarterly and add it to our
original investment and then calculate the interest on the total amount for the
next quarter and then keep on repeating it until the FD matures. (Compound interest was interesting on paper
but not while solving in school!)
Assuming
that one does not want to get the interest at specific intervals of time (for
which one needs to choose MIS – monthly installment scheme or likewise) and is
looking forward to the lump sum (starry
eyes at the thought of it) at the end of definite number of years, here is
how we can calculate the maturity amount:
[Note:
In case you are not keen to verify the engineer’s stepwise calculations, please
check the boxes directly]
Ah,
we have finally got the formula! Let’s highlight these findings.
Wait!
Did I mention tax? Yes dear! Every single paisa we earn as part of FD interest
(including the tax savings schemes) is taxable. Do not get misguided with the
fact that the banks (actually individual branch of the banks) are supposed to
deduct tax only if the interest amount against FDs created at that branch
exceeds `10,000. Whatever tax is not deducted, we will be still
liable to pay that while filing I-T returns if our total income is not NIL
after the deductions and exemptions. However, I’ve observed that banks do not
keep that cap of `10,000 and they deduct tax outright unless we submit
some forms.
If I
want to save tax (who doesn’t? I wonder!)
then I need to ensure that after I create a new FD account, I’ll submit 15G
form (15H for senior citizens! Few
decades left for me to move into that category!) as soon as possible and
keep on ensuring fresh submissions at the beginning of every financial year
till the FD matures. However, not all of us are eligible to submit 15G/H. There
are certain conditions and I would prefer to be in that category where I’m not
eligible to submit 15G than to have a lower income per annum. For the
conditions, read this article I found on internet - http://www.dnaindia.com/money/comment-who-is-eligible-for-filing-forms-15g-15h-and-how-to-save-tds-1582203 (Please note, the article is 4 years old so even though the rules are
same the tax slab will differ depending on the financial year!)
Fine!
So we are in a state where we are not allowed to submit 15G/H, then how much
will we get after maturity?
TDS
or the tax deducted at source is 10% of the interest in case PAN (Permanent
account number) details are mapped against a particular FD account. If PAN details
are not mapped then TDS is 20% L (irrespective of the fact that one owns a PAN card and keeps it safely
tucked in a plastic bag but fails to get it updated against the FD account or
the savings/current account held in that bank as part of KYC – Know Your
Customer).
Please
note, if my tax slab is not meant for 10% then whatever money I’ve saved with
the bank deducting outright 10% TDS, I might have to pay tax on that while
filing I-T return. There is no way to escape and in fact one should not try to
escape as well. Since the time 26AS has appeared on income tax portal, it has
become quite easy to find out that how much was the total income from interests
(even though one gets to own the amount on maturity).
Oh my
my! I’ve spoken at lengths about this whole procedure without finding out the
formula to find post tax how much one would earn! Blame it on the keenness to
share knowledge!
Just
like the interest, the tax is deducted quarterly as well.
Using the
previous method hence we find that,
Now where n is
greater than 1, it would be quite difficult to manually keep on adding to find
out the TDS.
I won’t be able
explain but I’ve found that the above formula is equivalent to the following:
As
one can observe, tax deduction in every quarter affects compounding apart from
its natural purpose. As a result, one ends up having much lesser maturity
amount than promised.
Just
to get rid of mathematical expressions and work with real numbers, let’s have a
million to invest for 10 years! Do not roll your eyes! I agree that a million
is not a regular sum that we invest, still it sounds cool to work with. Come
on; now don’t complain about 10 years. Yes it’s a long time – little kids would
turn into adults by that time but the long duration would yield huge returns as
well. Now, I think I’ve got you hooked. Why not more than 10 years you ask, now
that you are totally looking forward to the huge returns? Banks which are
functioning for centuries do not dare to put the maximum duration of investment
to more than a decade for various reasons. So, we have to be happy with 10
years! Ok?
So!
1
million (i.e. 10 lacs if you are in doubt!) and 10 years with 8% interest rate
let’s assume!
Maturity amount assuming no tax has been deducted
If we
round off the amount, it becomes `2208040/- (#Whistlebaja)
In a
decade, a million becomes more than 2 millions! Simply, wow!
However…
Yes!
The howevers and buts are required because we now need to consider TDS for 10
years as well.
Where
does that leave us? Let’s see..
Maturity amount assuming TDS at 10%
If we
now round off this amount, it becomes `2041320/-
So we
missed out on receiving `(2208040 – 2041320) i.e. `166720/-
Ouch!
More than 1.5 lacs gone missing in thin air but the investment got doubled at
least.
If we
investigate further, this is not the total amount of tax that one would pay in
10 years.
Total tax paid assuming TDS at 10% in 10 years
This
can be rounded off to `115702/-
More
than 1 lac I see! Not bad, it would be utilized for nation building!
Where
is the rest of the money? It never got compounded honey! Remember? TDS affects compounding
as well.
So,
to summarize:
P.S. Assuming an average
inflation of 8% per annum (which means that the value of `100 falls to `92 in one year), the total interest earned at maturity would have a
lesser value technically than what was the assumed interest value during
investment. This is because of the reason that FD interest rates are around 8%
on an average. (#Dilkearmaan
aansuomebehgaye)
P.P.S. To overcome the
previous situation, one can try investing in mutual funds which are even though
subject to market risks, yield good returns over long term of investment,
checking inflation as well as adding to wealth creation. Do check this if you
are interested in mutual funds –
P.P.P.S. It is observed that
banks pay a bit higher interest rate for the range of 2-3 years of investment
than that for the range of 5-10 years. So, it’s better to invest for the range
with highest interest rate and reinvest the whole amount in the same manner
until 10 years are completed (in case 10 years are the intended duration of
investment). In this manner, the total income would increase.
P.P.P.P.S. Feel
free to highlight any corrections to be made. Feel free as well as to share the
article with friends and family if you find it helpful.
P.P.P.P.P.S.
Happy Investing! J
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