Fixed Deposit Laddering – How It Works, Benefits & Factors to Consider

Fixed deposits are considered lucrative long-term investments in the Indian financial markets. But even so, investors should research their options before choosing fixed deposits. The value of your corpus locked in for several years is deeply susceptible to the inflation trajectory. When inflation rises, the Reserve Bank of India reduces interest rates to counter it and vice versa. The return on investment in a fixed deposit is directly proportional to these interest rates. Therefore, fixed deposits earn a better return when inflation is low and the interest rates rise.

Let’s say you invest your savings in a fixed deposit for ten years. If the interest rates fall after you invest – your FD will earn less than it could. To avoid such lost opportunities, you want to invest in a fixed deposit account where you will get the best returns. That’s why, before investing in fixed deposits, it is best to research inflation and check what the Reserve Bank predicts for the economy. It will help you find the right time to invest.

Fixed deposit laddering can help minimise opportunity loss and optimise returns in FDs. Read on to learn more about how FD laddering works.

What is Fixed Deposit Laddering?

Fixed deposit laddering is an investment strategy that enables investors to earn a regular interest income while maintaining liquidity. The secret is to divide your corpus into smaller amounts and invest in fixed deposits of varying tenures instead of one fixed deposit with a large amount. The FDs in this portfolio have different maturity dates. As the FDs mature one by one, the investors can reinvest the money to maintain a regular interest income.

FD laddering is a flexible and balanced method that enables investors to earn better returns from fixed-income investments while maintaining liquidity for emergencies.

How Does FD Laddering Work?

The essential aspect of FD laddering is that investors need not commit all their money to one interest level. To understand how FD laddering works, here is an example –

Principal Amount (INR) FD Tenure (Years) Applicable Interest Rates (%)
5,00,000 1 7.4
5,00,000 2 7.55
5,00,000 3 7.65

In this example, if the interest rates start rising after you invest – the money invested for three years will suffer the most significant opportunity loss. It would be a considerable loss if you had invested your entire corpus for three or more years. However, the impact of rising interest rates and inflation is tapered due to fixed deposit laddering. After one year, one of your FDs will mature, and you can reinvest that at higher interest rates. That will further offset the opportunity loss due to inflation.

What are the Benefits of Fixed Deposit Laddering?

  1. Higher Interest Earnings

    Fixed deposit laddering enables you to earn a higher interest on your investment. FD laddering earns significantly higher returns than savings accounts or a single FD. As each FD matures, you can reinvest it at a higher rate to maximise your returns.

  2. Liquidity & Flexibility

    If you invest all your money in one fixed deposit, the amount is locked in for several years. Investing by laddering enables you to maintain liquidity and flexibility. You can get frequent access to your funds as the FDs mature and choose to use the funds or reinvest them as needed.

  3. Risk Management

    FD laddering prevents you from putting all your eggs in the proverbial basket. It allows you to diversify your investments and reduce the risk involved. Although fixed deposits are low-risk investments, there is a risk of decreasing returns due to inflation. It can be minimised by FD laddering.

  4. Attaining Long-Term Financial Goals

    FD laddering can play a vital role in helping you achieve your long-term financial goals. If you wish to create a corpus for your children’s education or retirement, you can create multiple FDs with different maturity dates. It will guarantee a regular interest income without worrying about fluctuations.

  5. Saving Tax on Interest

    If you have an FD that earns an interest of more than INR 40,000 per year, you are liable to pay tax on this income. However, with FD laddering, you can spread out your corpus in several FDs, all earning interest lower than INR 40,000 per year. And thus, save taxes.

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What are the Factors to Consider Before Opting for FD Laddering?

  1. Investment Objective

    Consider your long-term financial goals before choosing your investment avenues or the appropriate fixed deposits for laddering. Align your fixed deposit maturities with your financial goals to ensure cash flow when needed.

  2. Risk Tolerance

    Investment choices depend on your risk appetite. Those willing to take a risk to get higher returns can invest their savings in one fixed deposit or even other financial instruments like mutual funds. However, risk-averse people should opt for FD laddering to minimise the risk.

  3. Liquidity Needs

    Your liquidity needs are a significant factor to consider before you invest. The maturity dates of your FDs should align with your liquidity needs. It will ensure that you have funds whenever you need them.

  4. Tax Liability

    Take a close look at your tax liability and choose investments with the most tax efficiency. FD laddering may not benefit those in lower tax brackets, but people in higher brackets can reduce their tax liability by FD laddering.

  5. Interest Rate Scenario

    As the returns on fixed deposits are directly proportional to the inflation and interest rates, it is best to research interest rates before building an FD ladder. Time your investments to coincide with falling interest rates for the best returns.

  6. Terms & Conditions

    Read the fixed deposit terms and conditions thoroughly and ensure you understand them. There are penalties for early withdrawal, interest rate risks, and renewal options that you should know about before investing.

Fixed deposit laddering is a unique investment approach that offers investors stability, liquidity, and flexibility. By diversifying funds across fixed deposits, investors can enjoy better returns with minimum risk. Those who time their FD laddering investments well, reinvest regularly and consider all factors before building their FD ladder can earn significant returns through this method.
After considering the above factors, if you feel that fixed deposit laddering is the best choice for your financial portfolio, start investing in fixed deposits today!

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