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Tuesday, August 14, 2012

Ladder your Fixed Deposits

A simple technique like "Laddering" can not only help you make your Portfolio more liquid, but contribute quite substantially to building your Nest Egg faster...Read on..


What is a Fixed Deposit
(Fixed Deposits) FDs are the deposits that are repayable on fixed maturity date along with the principal and agreed interest rate for the period. Banks generally pay higher interest rates on FDs than the savings bank account, but may also charge you penalty in case of pre mature withdrawal.

What is the issue with doing Fixed Deposits
We all know that the interest rate on Fixed Deposits keep varying over time. While that is true with most investments, we must have a strategy to make sure that we get an almost consistent rate of return so that our income from our corpus is not impacted heavily because of change in interest rates.

How do we ensure consistent returns year on year from FDs
We can make sure that we get a consistent stream of income from Fixed Deposits by leveraging a concept of Laddering of Fixed Deposits

What is Laddering of FDs
Laddering is a process by which an annual stream of FDs is created for a long period. Let us take an example. If you create a stream of 5-6 FDs each year (one FD every 2 months interval), and do this for 5 years and after the 6th year, when they start maturing, you can re-invest them at the prevalent market deposit rates. This makes sure that your rate of return from FDs is reasonably consistent.

As a long term investment, Laddering will give you an average return and help you prevent your corpus from maturing at the lowest interest rate cycle. This concept of laddering applied to FDs is very similar to the concept of SIP (Systematic Investment Plans) applied to mutual funds or stocks.

The book "From Rat Race to Financial Freedom" will talk in detail about Fixed Deposits and how is this debt based investment tool different from other investment tools - its advantages and disadvantages

Happy investing

Cheers

Manoj Arora

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