FD laddering: Safety of bank deposits, with greater liquidity and interest options

Fixed deposits (FDs) are all-time favourites. A big drawback, however, is that though the instrument offers good liquidity, premature withdrawal — referred to as ‘breaking an FD’ — could lead to loss of interest. This is where FD laddering comes into play.

Laddering involves booking FDs of different tenures and interest rates in a manner that they mature at regular intervals of time. This strategy enables investors to avail of the benefits of FDs, without incurring penalties for breaking a single long-term FD if funds are needed.

Here’s an example. Let us assume that an investor has Rs 3 lakh in hand. Instead of investing the entire amount in a single FD for three years, she breaks it into three FDs of Rs 1 lakh each. The first is invested for one year, the second for two years, and the third for three years.

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In this manner, a ladder is created with three different FDs, each maturing a year apart. At the end of the first year, the investor renews the matured FD for three years, creating the next rung. In the following year, the FD with the two-year tenure matures, and is reinvested for three years, creating yet another rung. This provides the investor with liquidity at the end of each year.

Timing investment

Generally, long-term FDs offer higher interest rates. However, timing the investment is important here, owing to the risk of money being locked up for a longer tenure at a low rate of return. Speaking to The Federal, Virat Diwanji, Group President and Head – Consumer Bank, Kotak Mahindra Bank Ltd, says, “A normal customer may not be able to gauge the interest rate peak. With laddering, investors can avail of liquidity by opting for short-term deposits, which could be prematurely withdrawn in case required.”

An FD ladder does away with the need for investors to speculate interest rate movement in order to gauge a good time to book their FDs. That is, laddering allows them to book only as per their requirements. This strategy results in the averaging of interest rates, as some FDs may get booked at lower rates, and others at higher rates.

So, even if it is not possible for investors to book all their FDs at the highest rate, laddering secures them from getting the lowest rate on all their investments. The spreading of investments across FDs with different tenures and rates minimises the impact of interest rate fluctuations.

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It also allows investors to earn higher interest rates than a regular savings account, with equally good liquidity. As each FD matures, the funds can be reinvested in a new FD with a higher interest rate, maximising earnings.

With FD laddering, investors can plan for future expenses, as they can time the availability of funds according to their requirements or goals. This could be for a bigger investment, marriage, education, retirement, and holidays, among others. Also, senior citizens can rely on the interest earned on their FDs to meet their daily requirements, and use the liquidity for any other purpose when each FD matures, or reinvest the funds.

Financial goals

Diwanji adds a word of caution. “Before opting for the approach, one needs to be sure about the financial goals for which you are investing in these FDs,” he says. “Hence FD maturities need to sync with one’s cash flow needs. If investors’ goals ask for greater liquidity, they are advised to invest larger amounts in short-tenure FDs.”

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FD staggering is recommended for conservative, risk-averse investors who park significant amounts of their corpus in fixed deposits. Speaking to The Federal, Manavi Prabhu, Head – Fixed Income, Anand Rathi Shares and Stock Brokers, says: “By diversifying tenures, the investor can maintain a balance between short-term liquidity and long-term goals. FDs can be laddered in banks, as well as in deposit-taking NBFCs like ICICI Home Finance and LIC Housing.”

At present, no financial firm in India offers staggered FD as a formal investment instrument. Investors make the decisions independently, as per their limits and requirements, or seek help from wealth managers.

Diwanji advises investors to plan the staggering after evaluating the interest rate trends. “In an increasing interest rate scenario, it may work better to have money parked in short/mid-term tenures, as compared to a declining interest rate scenario, where locking funds for longer tenures makes more sense to optimise the returns,” he says.

Prabhu is of the same view. She says, “FDs are now witnessing a lot of demand. However, there may or may not be a hike in interest rates, going forward. In such a situation, where interest rates have more or less peaked, FD laddering may not be the best strategy. Instead, investors should lock in investment in an FD with a higher interest rate, if they do not need any interim liquidity.”