According to many financial experts, it is impossible for retail investors to predict the interest rates. That is why laddering helps optimize returns. Laddering is an investment strategy in which investors purchase multiple financial products with several other maturity dates. It helps in avoiding the risk of reinvesting a big portion of assets if the financial environment is unfavourable. For instance, if say you have fixed deposits maturing in 2012 and 2015, so even if the interest rate drops in 2012 when one deposit comes up for renewal, half of the income is locked at higher rates until 2015. Choosing the right financial instrument for investment is crucial but also daunting. Safety is key to any investment plan and FD is one of the safest plans for your retirement. Fixed deposits are designed to provide you the maximum returns at a minimal risk.
When do you need laddering?
This will answer your question. Reinvestment is one of the risks you carry while investing in fixed income products like FD. This means that you are not sure whether you will be able to reinvest the amount at the same or a higher rate during renewal. This is one risk investors have to be prepared for in every fixed income products — be it fixed deposits or bonds. Typically, many FD investors try to wait for interest rates to peak before locking their deposits, they hope for a bulk of their money being locked in at the highest interest rates. But while doing so, they also lose out on returns, because in the interim period, they may see money lying idle in their savings bank account, earning lower returns. However even if they succeed in this, when their deposits mature, they have to accept the prevailing rates at that time, no matter what they are . If you break your fixed deposit, then you will end up paying a penalty and land yourself in a tricky situation. This is where laddering helps investors.
Most experts are of the opinion that laddering can be used with products, including bonds, company deposits, bank deposits, post office schemes, and fixed maturity plans of mutual funds. Hence, you can create a ladder with fixed income products like fixed deposit or with multiple products. It is a technique of creating a staggered income ladder. Take for example, if you want to invest Rs 3 lakh of your emergency funds for an indefinite time period and you are not sure which way the interest rates are headed in the coming years. If the interest rates go up, the investment will be locked in your current FD and you cannot benefit from the higher rates. However, if the rates were to go down you would want to have the money locked in at higher FD rates. So the simplest laddering technique would be to invest Rs 1 lakh each in a 1-year, 2-year and 3-year fixed deposits.
How laddering helps?
In this investment strategy, a ladder is setup to have one product mature at the end of every year, which is reinvested depending upon the period. The maturing product gives an opportunity to invest again, depending upon the then existing interest rate scenario.
- Laddering is very useful for retired people who depend on interest income to meet their day to day expenses.
- Laddering can free up capital as and when required. This gives you access to funds in an emergency. A person may purchase a shorter-term deposit to meet any need for capital to fund his children’s education and purchase longer-term fixed deposit for retirement.
- Laddering gives you optimal return with safety of capital and liquidity. By using this process over long periods, you should be able to average out your interest rates and get a good return from your fixed income portfolios.
Investing in secure tools like fixed deposits should be on every adult’s financial planning agenda. Innovative products like Fixed Deposit available on Finserv MARKETS offers you a hassle-free process online with minimal documentation and lucrative interest rates. Fixed deposits with non-banking institutions like Fixed Deposit available on Finserv MARKETS can fetch you a higher rate of interest every year, making it more appealing than a regular fixed deposit in a bank.
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