The Buyt Desk
Laddering your fixed deposit helps investors optimize the returns and even the risk of re-investment is taken care of. It earns high returns while giving regular liquidity.
For low-income tax slabs, investors Fixed deposits (FD) help to achieve short-term goals but they may not beat inflation. FDs are low-risk products and are best for investors with a low-risk appetite. Liquidity risk and reinvestment risk are the risks the investors face with FDs. The credit risk can be minimized when you invest in FDs issued by sovereign entities like nationalized banks or India Post. But liquidity risk will remain irrespective of with whom you have invested. Laddering of fixed deposits is the solution which can minimize the liquidity risk associated with FD.
What is fixed deposit laddering?
Laddering can be considered as spreading the fixed deposits across the timeline. Consider you have an FD of Rs 5 lakh. Divide this into 5 FDs and invest with maturity terms of 1, 2, 3, 4 and 5 years. With this, you will have an FD maturing every year and you can reinvest every year with a maturity term of 5 years to make sure you have an FD maturing every year. FD ladder is a good strategy for investors who depend on FD income, especially senior citizens. They will have liquidity and also good returns through this strategy.
Why is it a good time for FD laddering?
During the COVID pandemic, worldwide governments have infused enormous liquidity into the economy. High inflation is the output of this. Interest rates drop as inflation increases. Currently, if you park huge funds in FD for the long term at a lower rate, you may miss good returns. Instead spread your funds across different FDs and timelines so that the interest rates are reflected as it increases and FDs earn good returns.
How to create an FD ladder?
Consider you have Rs 3 lakh at your disposal for investment. Instead of investing all of 3 lakhs in one single FD for 3 years, it is better to split it into 3 FDs of Rs 1 lakh each with the maturity term 1, 2 and 3 years for 3 different FDs. This is FD ladder creation with investment in 3 different FDs and each maturing a year apart. After the 1st FD matures after a year, reinvest it into an FD for 3 years. Continue doing the same for the rest of the matured FDs. By doing so, you will have an FD maturing every year and the liquidity is taken care of.
What are the benefits of creating an FD ladder?
1. Avoid minimum return – When you have a long gap between the 1st and last FD in the ladder there is a minimum chance of your FD earning the lowest rate. Maybe only one or none have minimum returns.
2. Freedom from timing rate cycles – FD ladder will not give you the tension of looking out for the right time to invest. FD ladder is time-independent and returns are averaging the interest rate. You may not get the highest interest rate for all your FDs but sure you will not get the lowest interest rate for all FDs.
3. The best interest rate – The highest interest rate is always given to long-term FD. When on the FD ladder, after the first few years all your FDs will be long-term FDs earning best interest while you will still have liquidity.
4. Liquidity without losses – Regular liquidity is what the FD ladder provides. As you will have an FD maturing very frequently, you need not break the FD at loss during a financial crunch. With an FD ladder, you will have many windows of liquidity.
5. Reinvestment risk – You may have a risk of low returns when you want to reinvest your funds if you have one lump sum FD. By FD laddering, all your money will not come for re-investment at a single point in time.
