Dubai: When looking at a safe means to or just to ensure that you have enough saved up for a rainy day, instead of setting aside idle cash that won’t get you returns, an age-old go-to option for many are fixed deposits (FDs). But gone are the days when you simply lock-up funds for a fixed term.
Did you know that ‘laddering’ your fixed deposits can help optimise returns and manage your liquidity requirements much better? While this approach isn’t new, there is currently renewed interest in this idea of laddering your bank deposits. But let’s first see what it is and then how you can take advantage.
“While FDs are meant to stay invested till maturity and banks employ different charges to ensure that it stays that way, ‘laddering’ deposits is a way of staggering out your investment into multiple fixed deposit accounts to earn high returns,” explained Shehan Abbas, a Dubai-based banking analyst.
While FDs are meant to stay invested till maturity, ‘laddering’ deposits is a way of staggering out your investment into multiple fixed deposit accounts to earn high returns
How does FD ‘laddering’ work?
To understand how to ‘ladder’ FDs, an understanding of how banks process your deposits is vital. When you think about the business model of a bank, in the simplest form, it will take deposits from individuals who do not need the money right now.
The bank keeps the money secure and lends out a portion of the money to other people who need the funds. In order to entice people to deposit their money, banks will pay a certain level of interest. When a customer opens a FD account with a bank, he or she invests a specific amount of money for a set period.
The bank then pays interest at regular intervals until the date of maturity, at which time the account holder receives her original investment, plus all of the interest. FDs come in varying terms and may require different minimum balances.
With FD ‘laddering’, rates hikes help
The rate you earn typically varies by the term and how much money is in the account. In general, the longer the term and the more money you deposit, the higher the rate you are offered. (A longer term does not necessarily require a larger minimum balance.)
So, a FD with a shorter maturation time will offer you a decent return, but it pays to invest in a longer-maturing FD, which usually has a higher yield.
However, with ‘laddering’, you essentially divide the amount available into parts and create multiple FDs of different maturity periods initially, instead of booking one big FD for the long term.
If you need it soon, consider a FD with a shorter term. However, if you’re saving for something five years down the line, a FD with a longer term and higher rate may be more beneficial.
Also, consider the economic environment. Whenever it seems that interest rates are expected to rise, or if you want to open multiple FDs, ‘FD laddering’ can be a good option.
Also, consider the economic environment. Whenever it seems that interest rates are expected to rise, or if you want to open multiple FDs, ‘FD laddering’ can be a good option.
Why the renewed interest in fixed deposits or FDs?
“It makes sense to start ‘laddering’ your FDs when the interest rates are reversing,” said Abbas. “And that is what is happening right now with the FD rates set to increase worldwide in the near future.” “If you look at bank FD interest rates, you will see that there is an increase in the rates in 2022 and 2023.”
Overall interest rates may change during your FD’s term. If rates rise, you miss out on earning those higher rates, since your money is committed for the FD’s term. However, if rates go down, you benefit: You still earn the higher rate that was offered when you opened the FDs.
FD ‘laddering’, buying multiple FDs of varying term lengths, can help address this concern. It can also be a way for you to take advantage of longer terms (and therefore higher interest rates) while still giving you access to some of your money each year.
As each FD matures, he reinvests the money at the current interest rate or uses the cash for another purpose. If he reinvests his money, he might choose a new 5-year FD, which would ensure he has one FD maturing each year as long as he continues ‘laddering’.
How does it benefit me to ‘ladder’ deposits as opposed to convention?
‘Laddering’ deposits offer a host of benefits not limited to easy liquidity. At the core, this method will help you stay in control of your investment at all times.
“’Laddering’ deposits will help you in reducing losses from premature withdrawal. Generally, banks will charge some extra amount when you opt for premature withdrawal. With ‘laddering’ deposits you can also wait for better rates in the market to invest in,” added Brody Dunn, an investment manager at a UAE-based asset advisory firm.
“You are also empowered by liquidity at regular intervals. ‘Laddering’ might not help much in getting higher returns in a go, but it will surely ensure that your returns are steady. ‘Laddering’ is ideal for near-retirees who have lump sum retirement funds to invest, as they will be ensured steady returns on a monthly, quarterly, or any other periodical frequency.”
Key takeaways
Both Abbas and Dunn agree that ‘laddering’ is not a perfect science, cautioning that if rates are lower one year down the line than what you are depositing for now, then you might stand to earn lower returns.
However, they add that in the long run, ‘laddering’ is more likely to offer better returns, than say a 10 year-fixed deposit that comes with a clause of premature withdrawal for extra charge.
While the FD ‘laddering’ strategy can help you make the most out of bank FDs, but care should be taken not to prematurely withdraw from the respective bank FDs.
“Ideally, you should select the tenure and the plan thoughtfully. If you are not sure about when you may need to withdraw your FD, look for banks that don’t charge a premature penalty,” advised Abbas.
If you are not sure about when you may need to withdraw your FD, look for banks that don’t charge a premature penalty
Also note that the fixed deposit ‘laddering’ strategy could work best, particularly when interest rates in the global economy are expected to move up – as it is currently.
By spreading the investment, you would have a chance to gain from rising interest rates. It averages out the changes in the interest rates over time.
“By practising the ‘laddering’ strategy, all your investments are not disturbed in case an emergency arises. With regular maturity proceeds year after year, liquidity is taken care of,” added Dunn.
