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Laddering FDs: How this strategy helps you make the most of your fixed deposit investments

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Look at the fixed deposit (FD) interest rates offered by banks and many fintech organizations, and you will find so many small finance banks (SFBs) scoring above the rest. For example, Unity Small Finance Bank leads the most attractive FD interest rate at nine percent per annum, followed by Shivalik Small Finance Bank offering rates at 8.65 percent per annum. Within the scheduled private sector banks, SBM Bank stands out with the highest FD interest rates, reaching up to 8.25 percent. Many public and private sector banks are also offering more than seven percent interest, encouraging many risk-averse investors to put most of their earnings in these traditional investments in one go.

Risk-averse investors look to FDs as a preferred option, looking for guaranteed returns and a low-risk investment. However, a related disadvantage is the mandatory lock-in period, and early withdrawal is penalized. The amount of the penalty varies among banks but is usually between 0.5 percent and one percent of the principal amount.

In addition to the penalty, withdrawing money too soon results in the forfeiture of interest on the amount withdrawn. This is due to the compounding nature of BD interest, where you earn interest on your already accrued interest. An early withdrawal affects the continued accrual of interest on the principal amount and the interest accrued on that amount.

A ladder strategy was adopted

Astute investors use a ladder strategy when investing in BDs. This involves dividing the funds into smaller amounts and distributing them to BDs with different tenures. By doing so, they cannot lock up all their capital in one BD, while benefiting from the higher interest rates offered by FDs with longer tenures.

The following example shows how one can implement a ladder strategy for BDs. Say you are 200,000 for investment. While putting all the funds into a five-year BD would lock in your money for the entire period, adopting a ladder strategy offers another approach. Spread the investment across FDs with different tenures, for example,

  • 50,000 in 1 year BD
  • 50,000 in BD 2 years
  • 50,000 in BD 3 years
  • 50,000 in BD 4 years

In this way, you will get access to 50,000 per annum, and you can also capitalize on the higher interest rates of longer-term FDs.

Why invest in a staggered way?

Implementing a laddering strategy with FDs can improve interest yields and mitigate liquidity challenges. Here are a few reasons:

  • Adaptability: Using a ladder strategy with FDs provides flexibility in your investment approach. You can modify the tenures and amounts of your FDs to align with changes in your financial needs.
  • Improved welfare: FDs with longer tenures tend to have higher interest compared to those with shorter tenures. The Ladder FDs enable you to take advantage of these rising interest rates, maximizing your investment returns.
  • Reduced liquidity deficit: With multiple FDs maturing at different intervals, you maintain constant access to some of your funds. This reduces the likelihood of needing to break FD prematurely and incurring penalties.
  • Loss mitigation during early withdrawal: In case of early FD withdrawal, the impact on your interest loss is minimized as compared to investing all funds in one BD. The loss is limited to the specific FD being broken, while the remaining FDs in your ladder continue to accrue interest.

It has been observed that many investors break into their long term FDs to get rid of their loans or prepay their debt. This not only disrupts the yield obtained from the FDs but also causes loss from the penalty due to premature withdrawal.

Ladder BDs offer investors a distinct advantage of consistent access to their funds due to the staggered maturity of the various BDs. This accessibility is valuable during unexpected expenses or when taking short-term investment opportunities.

Apart from facilitating regular access to funds, ladder FDs enable investors to achieve higher returns on their investments. This is attributable to the tendency of FDs with longer tenure to provide more attractive interest rates compared to their shorter tenure counterparts. Through the strategic application of the ladder, investors can take advantage of these better interest rates, increasing the overall returns on their investment.

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Updated: 18 November 2023, 10:48 AM IST

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