Have you ever wondered how to make the most out of your Fixed Deposits (FD)? Whether you are a beginner or a seasoned investor, it’s important to explore different features of financial tools that can help grow your wealth.
The strategy we are talking about is Fixed Deposit Laddering. This strategy offers stability and maximises the returns of your FDs.
Let’s understand how it works and how you can implement it practically.
Estimated read time: 3 minutes and 46 seconds
Buckle up, here we go!
For starters, fixed deposits, also known as term deposits, are a type of savings account offered by banks. They are a safe way to save money and earn guaranteed interest.
When you open a fixed deposit account, you agree to deposit a certain amount of money for a fixed period, typically ranging from a few months to a few years.
During this period, the interest rate on your deposit remains fixed, hence the name fixed deposit. This means you know exactly how much interest you will earn on your FD at the end of the term.
Remember, they lock your money in for the duration of the term. This means you cannot withdraw your money before the FD matures without incurring a penalty fee.
Fixed deposits usually offer higher interest rates than regular savings accounts. That makes them an attractive option for people looking to earn more on their savings.
What is Fixed Deposit Laddering?
Fixed Deposit Laddering is a strategy that involves distributing your money across multiple fixed deposit accounts with varying maturity dates.
By staggering your deposits, you ensure a steady stream of returns while maintaining liquidity and minimising risks. It’s like building a staircase where each step represents a different fixed deposit account.
How does Fixed Deposit Laddering work?
To better grasp this concept, let’s consider a real-life example.
Meet Raju, a 30-year-old IT professional who wants to invest a lump sum amount of ₹1,50,000 he has in FDs.
Raju already has an emergency fund and life and health insurance. He has been investing money every month through SIP to achieve his goals. Now, he has some additional lump sum money lying around for some time.
He wants to invest the ₹1,50,000 in FDs because he wants to earn a guaranteed interest from it and would like to access the money in an emergency.
Usually, Indian banks give better interest rates for a 3-year FD. So, Raju invests the entire lump sum amount in a 3-year FD.
The problem here is that his money is stuck for 3 years. If he wants to withdraw his money in case of emergency, he has to pay a penalty of 0.5% plus, the banks will also reduce the interest rate. He won’t receive the 3-year interest rate.
And if he saves his money in a short-duration FD, he will receive less interest compared to the 3-year FD.
In this situation, the FD Laddering strategy can help him earn better interest while maintaining good liquidity. Instead of putting the entire amount into a single FD, Raju implements FD Laddering.
Implementing Fixed Deposit Ladder:
Step 1: Raju invests ₹50,000 in a fixed deposit with a 1-year maturity period. This short-term deposit ensures that a portion of his savings is easily accessible within a short period.
Step 2: He allocates ₹50,000 in a fixed deposit with a 2-year maturity period. This allows Raju to earn a slightly higher interest rate compared to the 1-year deposit while maintaining a reasonable liquidity horizon.
Step 3: Raju puts ₹50,000 into a fixed deposit with a 3-year maturity period. This longer-term deposit provides Raju with a better interest rate than the previous two deposits.
Step 4: Rollover and Reinvest. After the first year, when the initial FD matures, Raju reinvests that money in a new fixed deposit with a 3-year maturity period, continuing the cycle. This way, he keeps adding a new rung to his savings ladder while enjoying better interest rates on his FDs.
As we said, with these steps, it’s like building a staircase where each step represents a different fixed deposit account. Implementing this strategy provides Raju with good liquidity, as one FD matures every year and also he is receiving the best interest rate on offer.
Yes, initially, for the first two FDs, he won’t receive the best rates, but once he completes the first cycle, he will receive the best rates with the 3-year tenure FDs.
Also, you can start this laddering strategy with small amounts. And slowly increase the amount over time as and when you receive or save any lump sum amount.
If you want more liquidity, you can add one more FD ladder starting after 6 months from the first. With this, you will have a total of 6 FDs. One FD will mature every 6 months.
Pro Tip: Invest in FDs of small finance banks. They give higher interest rates compared to bigger banks. Also, your deposits up to ₹5 lakhs per bank are insured by DICGC.
Didn’t know about this free insurance? There are a few more free insurance that most of you are not aware of. Read about them here.
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