Table of Contents

- What is the Fixed Deposit Laddering Strategy?
- Benefits of the FD Ladder Strategy
- #1 Diversification across tenures and institutions
- #2 Potential for higher returns if interest rates are rising
- #3 Liquidity
- Drawbacks of the FD Ladder Strategy
- #1 Too much effort
- #2 Returns will be lower if interest rates are falling
- Altcase’s Thoughts on the FD Laddering Strategy
- How to Implement the Fixed Deposit Ladder Strategy

Do not index

Do not index

FDs are simple instruments that help you to create long-term wealth with low risk.

But there’s this concept of FD laddering which (in our opinion) complicates the straightforward long-term wealth creation process.

In this article, we:

### What is the Fixed Deposit Laddering Strategy?

In the FD laddering strategy, you divide your money into tranches and invest them in FDs of different tenures.

Let’s say you have Rs. 3 lakh to invest. To implement the FD laddering strategy, you will divide it into 3 tranches of Rs. 1 lakh each and invest each tranche for a different tenures like 1 year, 2 years and 3 years. This is a simple FD ladder.

Now, how does this help?

Firstly, your

**FDs get spread across institutions**. Suppose you have Rs. 12 lakh to invest - you can invest 4 lakh each in bank 1’s 1 year FD, bank 2’s 2 year FD and bank 3’s 3 year FD and each of your FDs will be insured up to Rs. 5 lakh by the DICGC.Secondly, if the interest rates are rising, the 1 year and 2 year FDs can be

**renewed at higher interest rates**giving your returns a kicker.Finally,

**all your money is not locked-in for the longest tenure**of 3 years. Your 1 year and 2 year FDs will mature and give you the flexibility to use the money in the interim.Let’s look at all the benefits of the FD ladder strategy in detail…

### Benefits of the FD Ladder Strategy

#### #1 Diversification across tenures and institutions

By implementing the FD ladder strategy, you can diversify your FDs across not only the tenures but also the financial institutions.

So, you can have a 2 lakh, 1 year FD with bank 1, a 2 lakh 3 year FD with bank 2 and a 1 lakh 5 year FD with NBFC 1.

This diversification helps in three ways.

Firstly,

**your already safe FDs become safer when spread across institutions.**Here’s how:With banks you get Rs. 5 lakh insurance per FD by DICGC, an RBI subsidiary. So, the diversification across financial institutions is something that you should ideally have if you are looking to invest more than Rs. 5 lakh.

The other two ways in which diversification can potentially help are explained below.

#### #2 Potential for higher returns if interest rates are rising

Suppose you used the ladder strategy on Rs. 5 lakh and invested Rs. 1 lakh each in 1 year, 2 year, 3 year, 4 year and 5 year SBI FDs. Let’s assume the following interest rates:

FD tenure | FD amount | FD interest rate* |

1 year | Rs. 1 lakh | 6.8% |

2 year | Rs. 1 lakh | 7.0% |

3 year | Rs. 1 lakh | 6.5% |

4 year | Rs. 1 lakh | 6.5% |

5 year | Rs. 1 lakh | 6.5% |

**Actual interest rates offered by SBI in May 2024*

The average interest rate of the above FDs is 6.6%.

Now suppose that throughout the 5 years, the interest rates on FDs is higher than the interest rates you have locked while implementing the ladder strategy.

So, every time an FD matures, you have the chance to renew it at a higher interest rate such that all your money matures after 5 years.

So, after the 1 year FD matures, you’ll renew it for 4 more years. After the 2 year FD matures, you renew it for 3 more years and so on.

FD tenure | FD amount | Old FD interest rate | Maturity action | Interest rate on new FD* |

1 year | Rs. 1 lakh | 6.8% | Renew for 4 years | 7.0% |

2 year | Rs. 1 lakh | 7.0% | Renew for 3 years | 7.25% |

3 year | Rs. 1 lakh | 6.5% | Renew for 2 years | 6.8% |

4 year | Rs. 1 lakh | 6.5% | Renew for 1 year | 6.8% |

5 year | Rs. 1 lakh | 6.5% | Withdraw | Not applicable |

**Assumed interest rates during renewal*

The average interest rates on the 4 renewed FDs + 5 year FD is 6.87% (higher than the 6.6% average of the old FDs)

Note 1:In this example we assumed that we will simply renew the FDs because the interest rates have marginally increased. But this is not necessarily what’s to be done. You can simply invest in a different asset class altogether that may have a higher return potential at that point in time.

Note 2:You may also want to use the interim FDs if you have a financial goal - something we consider while explaining how to implement the ladder strategy a couple of sections later.

It is crucial to note that this works only if the interest rates during renewal are higher than the interest rates during the creation of the FD ladder.

**It is almost impossible to guess where the interest rates will be in a few years.**Even the most experienced investment professionals and economists get their interest rate calls wrong routinely. Hence, this is just a potential benefit that you may not enjoy through your FD ladder.

#### #3 Liquidity

Liquidity refers to the ability of an asset to be exchanged for cash quickly and without losing much value.

The FD ladder strategy allows you to have interim liquidity when compared to investing in a single long-term FD.

However, this is not a very critical benefit because FDs are inherently liquid (with a small penalty for premature withdrawal). Moreover, it is impossible to estimate when you may need money in the future and ladder your FDs accordingly.

If liquidity is the only benefit you find useful, the FD ladder strategy is best avoided for the following drawbacks involved.

### Drawbacks of the FD Ladder Strategy

#### #1 Too much effort

Under the second benefit (potential for higher returns) of the FD ladder in the last section, we saw how cumbersome it is to execute a simple FD ladder.

First, you need to open multiple FD accounts. Next, you need to be vigilant during the time of each FD’s maturity and take a call on what’s to be done with the money. Finally, it may result in a suboptimal return if the interest rates fall when interim FDs mature.

This is something we discuss in the next section.

#### #2 Returns will be lower if interest rates are falling

Let’s imagine a simple FD ladder unlike an elaborate one in the earlier illustration.

FD ladder construct: Rs. 2 lakhs in total divided into 2 tranches - 1 tranche invested in a 1 year FD and other tranche invested in a 2 year FD.

FD tenure | FD amount | FD interest rate* |

1 year | Rs. 1 lakh | 6.8% |

2 year | Rs. 1 lakh | 7.0% |

**Actual interest rates offered by SBI in May 2024*

The average interest rate of the above FDs is 6.9%.

Now, a year later, you renew the 1 year FD for another year so all the money comes back to you in 2 years. But the interest rates have fallen during the renewal.

FD tenure | FD amount | Old FD interest rate | Maturity action | Interest rate on new FD* |

1 year | Rs. 1 lakh | 6.8% | Renew for 1 year | 6.5% |

2 year | Rs. 1 lakh | 7.0% | Withdraw | Not applicable |

**Assumed interest rates during renewal*

The average interest rate now becomes 6.75%.

So, had you not implemented the FD ladder strategy and simply invested the Rs. 2 lakhs in a 2 year FD, your returns would have been 7%.

This is the downside of the FD ladder strategy that few talk about!

### Altcase’s Thoughts on the FD Laddering Strategy

You may have realised that we are not super excited about the FD ladder strategy at Altcase.

The only aspect we like about the FD ladder strategy is diversification across banks/institutions because it helps you keep your money extra safe. So, if you have more than Rs. 5 lakhs to invest, it is wise to invest in multiple bank FDs.

But diversification across maturities may not make sense. This is especially relevant in 2024 as FD rates are among the highest in the last 10 years.

A more sensible investment strategy today is to lock-in high FD rates for the next few years with the bulk of your money.

If you still must implement the FD laddering strategy, here are the steps:

### How to Implement the Fixed Deposit Ladder Strategy

- Decide your investment amount + maximum tenure

- Divide the investment amount into tranches (tip - don’t create more than 4 tranches)

- Take your liquidity needs and your financial goals into consideration to decide each tranche’s size and maturity

- Invest as per the plan and decide the next steps at each tranche’s maturity

Illustration:

Let’s assume you have 10 lakhs to invest and the maximum tenure you can lock this money for is 5 years. You are sure you don’t need any of this money for the next 2 years. However, you would like the option to get Rs. 5 lakh at the end of 3rd year so you can buy a new car if you get bored of your present car. The FD ladder strategy needs to provision for this financial goal.

**Let’s try to create an FD ladder using this information.**

First, let’s solve for the financial goal.

To get Rs. 5 lakh in 3rd year, you need to invest a certain sum in a 3 year FD. Let’s assume the interest rate on a 3 year FD is 8%. So, to make Rs. 5 lakh in 3 years you need to invest Rs. 3.97 lakh (say Rs. 4 lakh).

Note - We are disregarding taxes and assuming annual compounding to keep things simple here.

So, we need to invest Rs. 4 lakh in a 3 year FD. Now, let’s deal with the other Rs. 6 lakh at your disposal.

Now recall that you are okay with locking all the Rs. 10 lakh for 2 years. So, we don’t need any FD that matures in less than 2 years. Great!

Here’s where we are in the plan right now:

Tenure | Amount to invest | Rate of interest | Note |

Less than 2 years | Nil | Not relevant | Don’t need money in less than 2 years |

2-3 years | Yet to calculate | 6.5-7.0% | Yet to figure out |

3 years | Rs. 4 lakh | 8.0% | Need the option to buy the car |

More than 3 years | Yet to calculate | 8.1-8.5% | Yet to figure out |

Let’s build a provision for some liquidity at the end of 2 years since you may want to use some money at this point. No worries even if you don’t, it can always be reinvested in FDs or other assets.

So, let’s say you decide to invest Rs. 2 lakh for 2 years. Now, we want to figure out how to allocate the remaining Rs. 4 lakhs.

Since 5 years is your maximum tenure, you should allocate some money to 5 year FD - let’s say this is all the remaining 4 lakhs. Awesome!

Here’s what the final FD ladder strategy looks like:

Tenure | Amount to invest | Rate of interest | Note |

Less than 2 years | Nil | 6.0-6.75% | Don’t need money in less than 2 years |

2 years | Rs. 2 lakh | 7.0% | May need some liquidity after 2 years |

3 years | Rs. 4 lakh | 8.0% | Need the option to buy the car |

5 years | Rs. 4 lakh | 8.25% | Okay with locking Rs. 4 lakh for 5 years |

That’s it, that’s how you can implement your FD ladder strategy too.

Here are a couple of additional tips:

- Diversify across institutions too - it helps you keep your FDs extra safe

- Keep it simple by creating a maximum of 4 tranches

Happy Investing!

Written by