What is Laddering - A Strategy to Manage Investment Risk

Key Highlights
 

1. Laddering strategy gives flexibility and security to your investment option (FD, Bonds, etc.)
    
2. If repo rates change or there are major ups and downs in the market, you can easily reinvest your investment accordingly with laddering.
    
3. Out of all other techniques (lump-sum, SIPs, bond strategies), laddering provides security, growth, flexibility and regular cash flow.

When you invest your money in different funds with different maturity dates, that is called Laddering. With this technique, there is stability in incoming cash and reinvesting. 

For example, you have ₹10,00,000 to invest. Instead of putting all of it in a single 5-year fixed deposit, you split it into five FDs of ₹2,00,000 each. Now, one FD matures after 1 year, the second after 2 years and so on. 

Let’s see what benefits it gives with the help of the table given below.

His total investment was ₹10,00,000, and the total maturity value is ₹12,48,580. The value is less compared to investing 10,00,000 in one FD. However, with laddering, you can reinvest your money in stocks or any other fund once matured, and you also get yearly liquidity. 

With laddering, you can also mitigate risks. If you find a certain fund risk worthy, you invest it for a shorter tenure and then evaluate its performance. This is the perfect strategy to manage investment risk. Let’s learn more about this technique in this blog,

How Laddering Works?

Just like a physical ladder, laddering has rungs. If you want to reach a certain height (return), then you don’t have to make a big jump (go all in). You can create rungs and then climb and reach your destination.

1. Building the Ladder

When you build a ladder, you don’t put the entire savings in one single fixed deposit (FD) or bond. Instead, like the rungs on a ladder, you split the money to get to the desired height. 

For example, Ramesh from Pune has ₹5,00,000 to invest. Instead of putting all of it in a 5-year FD, he creates a ladder.

The table will help you understand the rungs and the idea we are talking about.
 

So, every year, one FD matures. Ramesh can either withdraw the money (if he needs it) or reinvest in another 5-year FD.

2. Staggered Maturities

Let’s take Ramesh’s example from the previous point to understand this one. By investing with staggered maruritiues, he doesn’t have to wait five years for returns. That is how he got yearly liquidity, reduced reinvestment risk, and allowed reinvestment at higher rates if markets improve.

3. Managing Interest Rate Risk

Interest rates in India don’t stay the same. If you lock your money in one long-term FD when rates are low, you would lose the interest as per the new rates. That is why we say that laddering reduces this risk. 

For example, Ramesh started with a 1-year FD at a lower rate (6%), and when it matured, he reinvested the money at a higher rate (7.5%):
 

By laddering, he gained a profit of ₹7,950. He would be stuck with a 6% rate if he had gone for a ₹5,00,000 FD for 5 years. 

Do you know RBI has reduced the repo rates from 6.5% to 5.5%? Due to this change, the interest on FDs decreased. For instance, the rate for FDs in ICICI Bank for 46 to 90 days has been reduced from 4.25% to 4%. For 91 to 184 days, it is 4.5% from 4.75%. 

Benefits of Laddering

Fixed deposits are the first love for any Indian household. In 2021-22, household deposits made up roughly 57% of banking sector deposits. When you know something is safe, you want it to be flexible too. That is why people go for laddering. 

Let’s discuss more reasons why people prefer laddering. 
 

Laddering helps investors enjoy stable returns, access to funds, and reduced risk. They can also save on taxes. 

Risks and Considerations

With safety, flexibility, and easy liquidity, you also face some risks with laddering. Let’s discuss those risks in the table given below.
 

Laddering is safe, but factors like inflation can become a huge problem. Also, equity investments require active monitoring.

Laddering vs Other Strategies

When it comes to managing investments, different strategies serve different needs. Laddering is often compared with other approaches like lump-sum FD, SIP, barbell, and bullet strategies. Let’s break it down in this section.

1. Laddering vs SIP (Systematic Investment Plan)

A SIP is a monthly commitment for any investor investing in equities or hybrid mutual funds. The benefits arise from the rupee-cost averaging. You can have diversification across time and market cycles, but not interest rates.

For example, Antriksh invests ₹10,000/month in SIP. NAV goes from 100 to 80 to 120. Because of this fluctuation, the average cost = ₹95. If he had used laddering in FDs, he would have got ₹1,22,500 (3 years).