A fixed deposit or an FD is among the most common and preferred investment avenues in India. This is due to its multiple benefits, from assured returns to secured rates. However, it isn’t the most liquid investment, as certain issuers do have lock-in periods.
For tax-saver FDs, this lock-in period is five years, but for regular FDs, accessing your corpus is only possible via a premature withdrawal. This attracts a penalty or a fee and affects your returns. As such, it isn’t always the ideal option.
But laddering your fixed deposit is one way you could work around this. It allows you to leverage FD interest rates efficiently, while maintaining liquidity, too. Read on to learn more about this technique and how it helps you earn better returns.
How Does Fixed Deposit Laddering Work?
To ladder your FDs, you need to book multiple fixed deposits at varying tenors, for a set investing window. Investing for different periods allows you to get returns at set intervals, without any penalties.
You can then reinvest the matured or principal amount for a specified period, if suitable. For example, consider that you want to invest ₹15 Lakhs in an FD. Instead of making a single long-term deposit, you can divide the amount into five FDs maturing in one, two, three, four, and five years.
You can reinvest the deposit maturing in the first year for four more years. This way, you have a fixed deposit maturing every year and can leverage the changing interest rates. In general, issuers offer lucrative FD interest rates for tenors of 2-5 years.
Three Ways to Earn Better Returns Through FD Laddering
While the investing tactic is designed to ensure liquidity, there are ways to optimise it for returns. Here’s how.
Leverage Interest Rate Trends
While the FD interest rates do not change once you book a deposit, the rates fluctuate based on the repo rate and the issuer’s policies. As such, if you start a long-term fixed deposit and the issuer offers a higher rate after a year or two, you could miss out.
However, when you ladder your deposits, you have a better chance of leveraging these fluctuating rates and securing enhanced returns. It is crucial to note that you also risk getting a lower rate but you can always reinvest your money elsewhere.
Save More Through Tax Benefits
Fixed deposits offer a host of benefits, including tax benefits. As per the Income Tax Act, you can invest in a tax-saver FD and get deductions under Section 80C. The deduction limit under this section is ₹1.5 Lakhs.
The tenor for a tax-saver is five years, which falls within the ideal range to leverage better FD interest rates. So, if you choose to ladder and have a 5-year horizon, invest a portion in a tax-saver FD. You can invest other portions of the corpus at shorter tenors to ensure liquidity all through.
However, it is crucial to keep in mind that you cannot make a premature withdrawal until the end of the tenor. Moreover, the deduction limit of Section 80C is inclusive of all the eligible investment avenues. So, be sure to line up your investments accordingly.
Reinvest to Accumulate Better Corpus
When it comes to earning good returns from an FD, staying invested for the long run is ideal. This means that you should have a clear plan in place, so that you can truly add to your wealth. With laddering, it is wise to have a plan to reinvest your earnings partly, if not in full.
This is because you could have the opportunity to secure higher FD interest rates during the 5-year window. If that is the case, you can reinvest the earnings and add to your wealth efficiently.
Things to Consider When Laddering Fixed Deposits
Laddering requires proper planning, and there are a few things to keep in mind before you employ this strategy.
Tax Liability
Although the tax-saver fixed deposit offers tax benefits, the interest you earn on them is subject to tax liabilities. However, it is applicable only if the yearly interest earnings exceed ₹40,000 (₹50,000 for senior-citizens).
Moreover, the limit is cumulative for all the FDs you hold with a financial institution. This is noteworthy since laddering requires you to invest for multiple tenors. Each will earn different returns at varying FD interest rates, and this could increase your tax liability.
Interest Rates Cycles
FD interest rates are subject to fluctuation. Ideally, laddering fixed deposits is the best strategy when the interest rates are expected to rise. As such, assessing the trend is crucial to getting the most out of laddering. If the rates drop, you may not get the same earnings, as expected.
The past few years saw an upward trend in the repo rate. However, there are speculations that the rates will fall by the end of 2023 or the start of 2024.
Liquidity Requirements
Any investment strategy that is not in alignment with your goals is ultimately futile. The key benefit of FD laddering is that it offers liquidity, making it perfect for staggered financial goals.
So, make an informed decision and only ladder your FDs if you need the liquidity. Opting to ladder your FDs without a viable reason will only limit the returns you could generate. This is because you lose out on the potential interest you could have earned by staying invested.
Tips to Optimise Your Fixed Deposit Investments
For your fixed deposit investment, try the following tips to retain access to funds without compromising on earnings.
- Assess your maturity amount and investment horizon
- Compare the FD interest rates of different issuers
- Use an FD calculator to plan your investments
- Evaluate your risk tolerance
- Read through the terms and conditions
Laddering fixed deposits is easy, and it adds value to your portfolio. However, optimising your investment with the above tips will allow you to make the most of your investment. It can also help you diversify your investments, which is a major benefit. Diversification helps mitigate the risk of your investments and enables you to secure your finances.
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