Fixed deposits are becoming an increasingly popular option as a secure investment option. A key reason is the lucrative interest rate on the FD that facilitates better returns on your investment. However, strategizing your investment is crucial to boost returns and secure better growth.
While you can strategize investing in different avenues, you must also consider changing your strategy for each avenue. One investment strategy for fixed deposit is laddering your FD account. From better returns to liquidity, laddering FDs is beneficial in more ways than just one.
Read on to understand what laddering is and how it helps boost your returns with the current interest rate on FD.
What is Laddering?
In simple terms, laddering is an investment strategy where you open multiple FD accounts with different tenors. For example, assume you want to invest ₹5 Lakhs in an FD account with one financial institution.
Instead of making a single investment, you can divide the investment amount and invest in multiple FDs maturing at different tenors. You can invest ₹1 Lakh for 1 year, another ₹1.5 Lakhs for 2 years, ₹2 Lakhs for 3 years, and so on.
Doing this helps maintain the liquidity of funds, allowing you to adjust and invest as per your requirements. It also allows you to make the most of your investment and earn better returns, as explained below.
Benefits of Laddering FD Accounts
While opening an FD account is a part of diversifying your portfolio, you need to further spread your investment in a fixed deposit. This is because the interest rate on an FD may change as per repo rate changes by the RBI and the financial institution’s policy.
The change can either lead to higher or lower interest rates. In the case of the latter, you do not stand to lose as much with an unstaggered FD. In the case of higher rates, however, you miss the opportunity of earning more returns.
Since laddering results in your FD maturing at different periods, you can bank on these interest rate changes. This ultimately helps you earn more and accumulate a better corpus that meets your financial goals.
In laddering, you can reinvest the funds or use them to attain your goal after the maturity of each FD. If you reinvest, you can get a better interest rate on the FD and earn better returns.
However, you have a single maturity period if you have a regular FD. While a long-term investment can help you earn good returns, the short-term may not yield similar returns.
Fixed deposit issuers do not allow premature withdrawal from your fixed deposit. In the case that they do, the withdrawal is subject to a penalty. As such, when you invest in a fixed deposit for the long term, you lock your funds with the financial institution.
This can cause financial stress, especially in times of emergencies. You may have to end up taking on a debt that can consume the returns you earn. However, you can avoid this by laddering your FD investment.
As mentioned, FD accounts mature at different tenors in laddering. You get access to quick funds at regular intervals. This access injects liquidity and allows you to meet any emergency requirements easily, without any stress.
Given the changing economic landscape and the fluctuating interest rates, keeping your investment flexible is great for making the most of every situation.
Moreover, since regular fixed deposits do not permit premature withdrawal or any other changes, you cannot quickly adjust your investment to the current market changes or your finances.
However, laddering allows you to have flexibility and control over your investment. This is because FD accounts mature at different intervals. This, in turn, allows you to adjust your investment as per your goals, finances, and economic situations.
The returns you earn from the interest rate on an FD are subject to taxation. The tax deduction happens if your returns exceed a certain amount for the given financial year. This can result in a higher tax deduction and reduced returns.
However, when you ladder your FD accounts, the interest you earn from one long-term FD gets divided into multiple FDs. As such, your interest may go under the threshold limit, avoiding tax deductions.
Laddering allows you to capitalise on the fluctuating interest rate on FD and make the most of your investment. By opening an FD account with different financial institutions for different tenors, you can earn better returns while keeping your investment safe and secure.
Although FDs are generally safe and low-risk investment instruments, it is best to check the rating offered by top credit rating institutions in India. This rating indicates the safety and stability of your returns and investment.
Choose the one offered by a well-reputed financial institution with the highest rating. You should also use an FD calculator to estimate your returns and plan your investments accordingly to leverage your finances and the current interest rate on an FD.