A very large number of people still repose their faith in Fixed Deposits simply because the returns are fixed, predictable and relatively safer than equity market or mutual fund returns. But managing fixed-income investments calls for something more than an invest-it-forget-it strategy.
One such strategy is referred to as a fixed deposit ladder. It is a significant tactic and is of immense help for especially senior citizens, who depend on FDs for defraying a part of their regular expenses.
Avoid lumping
It consists in something simple, which is not lumping the entire funds into a single FD and, on the contrary, breaking it down into smaller FDs of different tenures. It manages both returns and interest income effectively.
If this strategy is adopted, an investor will regularly have an FD maturing for reinvestment at a higher rate of interest or withdrawing the proceeds for use.
Say you select a term of 3 or five years. The ladder strategy enjoins that one divides the entire corpus into smaller quanta over the period.
Spread FDs over time
One of the most significant effects of this strategy is that one does not end up easily locking the lowest rate for the long term. Spreading over the FDs over a period of time, one gets a spread on the interest rates. If one of them is a low one, chances are high that the others are higher.
However, perhaps the most obvious benefit of the ladder approach is that the depositor can easily access the money when needed. If a big sum is locked in for a long term one has to withdraw it before it matures, which inevitably leads to the loss of some interest income. But when the amount is divided into smaller quanta, the FD can be closed before maturity and it won’t result in a loss quite big.
The tenure of the smaller FDs will end at different points in time leading to easy access to money when an FD matures. In short, the ladder approach builds flexibility into the rigid world of FDs.
While it will not certainly lock the highest interest rates for all your investments, it will also prevent you from falling into the trap of locking the lowest. In a way, it bears conceptual similarity with SIPs in mutual funds which are designed to take advantage of averaging.
Importance of 3-5 years
The utility of choosing a 3-5-year frame is that most banks offer the best rates of interest for FDs with tenure between three and five years. For example, the biggest commercial bank in the country, SBI offer the best rates between 2-year and 5-year tenures. The strategy of having a few FDs a depositor has the freedom to get liquidity regularly while availing of the high interest rates available in the 3-5-year time windows.
Experts advise that one should strike a judicious mix of tenures – short, medium and long that will allow both high interest rates and liquidity in the interest earnings.
Point to remember
If a depositor has pressing liquidity needs, one should invest bigger amounts in FDs with lower tenures. Conversely, if liquidity is not a need, one should go for FDs with longer tenures.
One can also think of parking some funds in tax-saver FDs. These typically carry five-year tenures. This is crucial since if the total amount of interest income is significant, it will attract tax at the applicable brackets.
Also, a clear definition of financial goals helps in executing this strategy. People usually have three types of objectives – capital preservation, income generation and a bit of both. The laddering approach must align with the financial goals.
It is also not very prudent to trust one bank with all the investment. Different FDs could be opened with different banks.
The ladder approach puts zing into the predictable and rigid world of Fixed Deposits. Read on to know how it can benefit a depositor. Personal Finance Business News – Personal Finance News, Share Market News, BSE/NSE News, Stock Exchange News Today
