Suppose you invest your money in bank fixed deposits at the prevalent interest rate of say, 6% p.a. for a period of three years. While the bank FD rate would remain the same throughout the chosen tenure, you notice that the interest rates offered have risen after you have locked in your money in the FD. That would make you feel disappointed, right??Given that you could have got a higher rate of return if you had invested at the higher rates that were later offered.?
Well, what if we told you that there is indeed one way to cover that risk of opportunity loss as well as optimise your returns??The answer is FD laddering. Read on to find out what is and how it works.
As its name suggests, FD laddering is a strategy where an investor creates a ladder of FDs. How do you do that? By spreading your FD investments across multiple FDs and tenures rather than a single investment in a long-term FD. With FD laddering, you don¡¯t commit all your money at one interest-rate level that has been offered as the rate of return.?
This simple concept can help you optimise your FD returns.?To understand how laddering works, let's take an example. Suppose you want to invest Rs 6 lakh in total in bank FDs for a tenure of three years.
Firstly, you would split your corpus as given in the table below at the assumed interest rates applicable.
FD laddering using FDs | ||
Principal? | Tenure (years) | ?Applicable interest rate (%) |
Rs 2 lakh | 1 | 6.00 |
Rs 2 lakh | 2 | 6.50 |
Rs 2 lakh | 3 | 7.50 |
Better returns: You can look around for better FD rates and create a ladder with each step constituting the most rewarding FD of that tenure.
More liquidity: With FD laddering, one of your FDs would be maturing every year. This implies better liquidity. Without FD laddering, your money would be locked in for several years. Of course, FDs can be broken but then you also have to pay a penalty.
Higher degree of safety: You can spread your FDs in the ladder across financial institutions and reduce the risk arising from keeping all your money at just one bank or NBFC.
Also Read:?How Risky Is Investing In A?Bank Fixed Deposit?
Keep in mind that bank FD laddering can work against you if interest rates start to fall. That¡¯s because your fresh FDs would be made at lower interest rates, thus fetching you less returns.
However, do note that FD laddering is not a return-enhancement technique. Rather, it¡¯s a return-optimisation method that limits your opportunity loss due to a sudden rise in interest rates. So, don¡¯t expect it to always give you better returns than a single FD, as per ET Money.
An increase in interest rates of course means higher returns for FD investors, provided they are able to lock in at the right time. But, given that most of us cannot predict the interest-rate cycle, creating a bank FD ladder can turn out to be better than investing in a single FD. FD laddering up strategy can help optimise returns, as mentioned above. But remember that FD laddering doesn¡¯t guarantee better returns, since rates may fall instead of rise, depending on the economic conditions.
Also Read:?PPF vs?Bank?Tax Saver?FD-Which One To Choose For Tax Saving?
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