Today I am going to talk a little bit about Fixed Deposit Schemes.
Fixed Deposit (FD) Scheme is an easy and a great option for risk averse investors. Most retirees prefer to park their funds in FD to generate regular income. The income from FD does not beat the inflation but safety of principal and assured returns makes it attractive for investors who wants to seek regular income.
Let’s see how we can maximize the returns and get most out of FD –
Fixed Deposit Laddering:
This strategy can be used to get most liquidity and lower risk of interest rate volatility. Let’s understand it better with an example:
Mr. A, is a retiree and wants to make a FD of INR 3 lakhs for 3 years. If he goes with typical usual method of 3 year single FD then he will simply put the money in it and will enjoy the income at the given rate. But what if after 2 years, bank raise interest rate? Mr. A is still getting less interest rate than the current rate. Or say after 3 years interest rate goes down? He have to invest his money at the low rate without any option.
Now, there is a better way – which can help Mr. A in this case and it is called as ‘Laddering’. Fixed Deposit laddering consists of creating an investment ladder, step by step and spreading the investment amount across multiple maturity periods but at equal duration.
Let’s go back to the same example.
With laddering, Mr. A can break the amount of INR 3 lakhs into 3 equal parts of 1 lakh each rather than investing the entire amount for entire 3 years. He will invest 1 lakh for 1 year deposit, next 1 lakh for 2 year deposit and last 1 lakh for 3 year deposit to make a ladder, such as it will be like 3 FDs with 3 different time durations. Further, he can re-invest the one year deposit when it gets mature in another 3 year deposit to create next step of ladder or if his 2 year deposits gets mature he can re-invest in another 3 year FD to get income in the fifth year; so on and so forth.
How much tenure works for the ladder depends on the investor’s liquidity needs and consideration of post-tax returns. Fixed Deposits with low tenure (e.g. quarterly) may have high liquidity but post tax returns will be low. This strategy gives you a couple of benefits like –
If any investor holding Fixed Deposit breaks it before maturity he need to pay penalty and also loses the interest amount. But with this strategy FDs with different maturity periods gives the facility of liquidity and without any penalty, Smart?
Easy Access to your Funds:
By laddering you always have some money maturing at equal duration. That way you can invest the amount in other options if you want or can re-invest in FD with high rate (if offering) to make next step of ladder. You can choose the maturity period for laddering like quarterly, half yearly as per your choice.
Guaranteed Regular Returns:
Laddering can give the benefit of regular and steady returns. This strategy is not for earning high interest rate but to get returns regularly and to minimize interest rate risk.
FD laddering is not a strategy to generate high income but to get maximum advantage of FD. It also has some drawbacks e.g. it will not give you a high interest in the scenario of rising interest rates.
Now, if you find laddering confusing or complicated, there is another strategy you can use. You can simply divide your amount in equal/unequal parts and make multiple FDs with different tenures. Remember the saying – “Don’t put all your eggs in one basket”!
Let’s see another example on how this will work.
Mr. B have INR 5 lakhs and wants to invest in Fixed Deposits. Now, instead of going with single FD, Mr. B has divided the amount in 3 parts (1 lakh, 2 lakh & 2 lakh) and parked it in 3 different FDs with different tenures (1 year, 3 year & 5 year). If he needs money after 1 year he can get it once his first FD is matured or in worst case he can liquidate any one of the FDs instead of breaking the whole and not losing the interest amount.
The last and simple strategy is to make Fixed Deposit for a longer duration, say 10 years when interest rate is at high. This way you will be able to lock your amount at high rate of interest for longer duration. This option will not give you liquidity but it could give you a high interest income.
I hope the above strategies help you get maximum benefit out of Fixed Deposits.