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What is Fixed Deposit laddering and how does it work?
Fixed Deposit laddering is a strategic move becoming common amongst Fixed Deposit investors. It allows you to earn FD returns while also ensuring liquidity in your investments. If you are planning to invest in Fixed Deposits, then employing Fixed Deposit laddering can be a great move to balance returns and liquidity.
What is FD laddering?
- Fixed Deposit laddering is an investment strategy whereby a lump sum investment amount is divided into multiple FDs.
- Each FD has a varying period of maturity. This enables you to invest amounts with staggered maturity periods instead of parking funds in a single FD.
- FD ladder strategy allows you to strike a balance between earning steady returns and liquidity, owing to maturity at regular intervals.
- Whenever you want to avail of funds urgently, you can withdraw from the FD with the nearest maturity date. This ensures not all of your FDs are broken to obtain money, thus ensuring uninterrupted growth.
- Automatic renewal ensures that the cycle of investment continues until you decide to close FDs.
How does FD laddering work?
- Decide your investment horizon: It starts with assessing your investment goals and determining your investment horizon. You should consider both short and long-term financial needs.
- Divide your investment amount: Divide your investment amount into multiple segments. Remember, they need not be equal. Divide it based on your short, mid and long-term financial needs.
- Choose maturity periods: Depending on your needs, you shall choose the maturity period for each segment. You can choose regular intervals between maturity periods, like 3 months or 6 months.
- Maintain consistency: Keep monitoring and reinvesting the FDs matured with longer maturity periods, thereby forming an FD ladder.
Why should you opt for Fixed Deposit laddering?
- Fixed Deposit laddering breaks down your investment amount and puts it in different maturity buckets.
- It provides you with the twin benefits of liquidity and higher returns.
- You can claim tax benefits with a 5-year Fixed Deposit.
- It helps you inculcate financial discipline and avoid premature withdrawal and consequent penal charges.
- It ensures consistent growth in wealth as every time an FD matures, you reinvest both the principal and the interest portion.
Key considerations for devising an FD laddering strategy
- Splitting right: When breaking up the lumpsum investment amount, it is important to split it right. There’s no thumb rule for splitting up and it all depends on your investment goal and your financial needs. Furthermore, how many segments you wish to split your funds also becomes important.
- Selecting maturity period: What’s the lowest maturity period you should select? What’s the interval you wish to keep between two maturity periods? It’s important to do it right to avoid any pre-mature withdrawal requirements in future.
- Checking the interest rates: When choosing the maturity period and splitting your investment fund, it is important to check the interest rate. Fixed Deposits offer different interest rates over varying tenures. Select the maturity period and amount such that it maximises returns while also meeting your investment goals.
- Avoid pre-mature withdrawals: Try to avoid pre-mature withdrawals as much as possible. Selecting the tenure and amount thoughtfully can help you ensure the same.
- Keep reinvesting: Every time an FD matures, reinvest it with a longer maturity tenure to keep the FD ladder going. You can also consider other avenues after maturity if required.
Select maturity period, amount as per your needs
You are free to decide the maturity period (i.e. the tenure of your bank FD) as well as the amount to form the ladder that suits your needs. You don't need to invest an equal sum across maturity periods; you may invest a bigger sum for a period that offers higher rates of interest.
Use laddering for Tax Saver FDs too
The FD laddering strategy can also be applied to investing in the 5-year Tax Saver FD. For this purpose, consider depositing your investible surplus in the 5-Year Tax Saver FDs every year persistently for five years. After five years you will receive the maturity proceeds out of your first Tax Saver FD, and after that every year you will receive the maturity proceeds of the ensuing tax saver FDs, i.e. the second, third, fourth, fifth, and so on.
Avoid premature withdrawal to maximise returns
The FD laddering strategy can help you make the most out of bank FDs, but care should be taken not to prematurely withdraw from the respective bank FDs. Ideally, you should select the tenure and the plan thoughtfully. If you are not sure about when you may need to withdraw your FD, look for banks that don’t charge a premature penalty.
Choose monthly or quarterly pay-out option to meet expenses
If you need funds before the maturity of any of your FDs, you can choose the monthly or quarterly interest pay-out. On the other hand, if you do not require interim cash flows, ideally choose the cumulative plan. Holding multiple fixed deposits in line with your financial goals and liquidity needs is an ideal thing to do.
Moreover, when you do not require the money at maturity, make it a point to renew or reinvest the respective fixed deposit receipt (FDR) to compound wealth better and counter inflation.
Benefits of FD laddering strategy
Note that the fixed deposit laddering strategy could work best, particularly when interest rates in the economy are expected to move up. By spreading the investment, you would have a chance to gain from rising interest rates. It averages out the changes in the interest rates over time.
By practising the laddering strategy, all your investments are not disturbed in case an emergency arises. With regular maturity proceeds year after year, liquidity is taken care of. And say, there is an emergency for which you need the money before the FD matures, you can always avail of an Overdraft (OD) facility against the FD.
The FD laddering strategy holds the following advantages:
- Diversifies investments across various maturity buckets.
- Different maturity periods, create investment loops (providing the option to reinvest).
- Potentially earns higher interest along with the safety of your capital.
- Addresses liquidity needs with staggering income of the maturity proceeds, helping you avoid premature withdrawals.
- Works for 5-year Tax Saver FD investments as well.
Also Read: 6 advantages of an Auto Fixed Deposit
Interest earned on a bank FD is taxable. If you have no other income apart from interest income, you can avoid TDS (Tax Deducted at Source) by submitting Form 15-G (for general or non-senior citizens) or Form 15-H (for senior citizens), as the case may be.
If you invest in bank FDs following the laddering strategy and with the necessary financial discipline, you can build a respectable corpus to address your financial goals, including contingency requirements. In other words, you could potentially get the best out of your investment in the bank FD.
Book your bank FD today by investing sensibly across maturity buckets. A Digital FD can securely generate wealth and add to your financial security and well-being.
Disclaimer: This article is for information purpose only. The views expressed in this article are personal and do not necessarily constitute the views of Axis Bank Ltd. and its employees. Axis Bank Ltd. and/or the author shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.
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