What is the secret of getting higher fixed deposit returns? Avoiding penalty on invested amount and keep the amount invested till maturity. Still, we need to make premature withdrawals from FDs. Laddering of Fixed Deposits (FD) helps avoid loss of interest, in case of premature withdrawal of money. In this method, the total amount should be invested in FDs of different timeframes.

Investment in FD comes with a guarantee of steady returns along with surety of principal protection. It is always advisable to park emergency funds in the form of FDs. Also, retired persons or senior citizens feel more comfortable with investing in FDs. They also offered higher interest rates. If we compare FD interest rates from banks, we find that small finance banks such as RBL Bank offer 8.3% per annum interest rates to senior citizens on 15-24 months FD. State Bank of India is also offering 7.6% per annum interest rates on 400 days FD to senior citizens (7.1% to public). Such higher interest rates entice many risk-averse investors to put their funds in these traditional investments.

While FDs offer guaranteed returns and a low-risk product, there are still some issues with it. Such as there is a mandatory lock-in during the tenure of FDs. Though you can withdraw by prematurely closing FDs, it comes with penal charges. Such penalty ranges from 0.5% to 1% in different banks. Other than penal provisions on FDs, investors also lose out on FD interest with withdrawn funds. Also, the investor is paid much lower interest on withdrawn funds.

Now you may understand, why banks keep on pushing customers to make FDs. This is most profitable for them. They get the money and due to premature withdrawal, they pay lower interest. Therefore, pre-mature closure of FDs results in loss of principal and interest amount.

Laddering Strategy: Strategy for higher fixed deposit return

In the Laddering strategy, the investor divides the investible FD amount into smaller parts and then creates FDs of different tenures, thus ensuring higher fixed deposit interest. The following example will help in understanding this better.

Assume, you have Rs. 5,00,000 for investment in FD.

Option-1: You would invest the entire Rs. 1,00,000 in a single FD of a tenure say, 5 years.

Option-2: Laddering strategy, wherein the investor divides the amount as below:

FD 1: Rs. 1,00,000 in 1 year FD

FD 2: Rs. 1,00,000 in 2 years FD

FD 3: Rs. 1,00,000 in 3 years FD

FD 4: Rs. 1,00,000 in 4 years FD

Now, suppose you need funds Rs. 70,000 urgently, say after 7 months of FDs creation.

In Option-1 you prematurely close FD. Pay penal charges of 0.5% – 1.0% of the principal amount i.e. Rs. 5,000. Also, interest will be paid to the extent of a tenure of 7 months.

In Option-2 you close FD 1 prematurely. FD 2,3,4 continues to earn interest with no penalty. There will be lower penal charges of Rs. 1,000. Thus higher fixed deposit returns. 

Thus Laddering strategy ensures that

1. There will be flexibility in investment options, as you have FDs of different tenures. So you liquidate shorter-term FDs first.
2. You have liquidity w.r.t. your investment. You need not liquidate a big FD. Rather a smaller FD liquidation serves the purpose.
3. You get a higher fixed deposit return on longer-tenure FDs. FDs opened for 4-5 years get the highest interest. Your substantial amount gets locked for the entire duration.
4. There is a lower penalty for premature closure. Since a lower amount of FD is liquidated first, the substantial sum remains invested.
5.  You can utilize money in emergency expenses with minimum loss in interest
6. Liquidity ensures that you can utilize the money if any other profitable investment opportunity arises.