<div><em>Investors especially those who are retired could benefit from laddering their investment in bank fixed deposit by managing interest rate risk, writes <strong>Sunil Dhawan</strong></em></div><div> </div><div>With the Reserve Bank of India maintaining the policy rates in the recent Monetary Policy report, the writing on the wall doesn’t change. The interest rate cycle had long overturned and is on its way down for the foreseeable future. The interest rates of banks are already down by 1-1.5 per cent since last year. Going by RBI Governor’s document, a decision for the uptick on interest rates by US Fed (in September) and the inflation numbers would largely determine how interest rates pan out in the immediate future.</div><div> </div><div>Lowering of interest rates understandably are favoured by corporates, markets and anybody who is a borrower. The biggest casualty are the fixed income investors especially the retired citizens who rely on fixed income for their regular income needs. A big portion of their deposits go into bank fixed deposits and senior citizens savings scheme. While senior citizens savings scheme is for a 5-year period and currently offering 9.3 per cent, the maximum that one may put in SCSS is Rs 15 lakh. The interest rate is set each year in April.</div><div> </div><div>That makes investors look at bank FD where interest rates are a function of several factor including the RBI’s policy rates. Presently, banks are offering interest rates around 8 per cent or even lower across most tenures. In them, they find solace of safety and assurance. In falling interest rate scenario, one is tempted to lock-in funds at highest rate which may not necessarily be the longest tenure. Each bank takes its own call on interest rate movement and also consider their own asset-liabilities equation before setting rates. </div><div> </div><div>For all those investing in bank FDs for their regular income needs or otherwise too, using the ‘Laddering’ approach will help. </div><div> </div><div>In Laddering, instead of putting the entire sum in a certain term-deposit, the sum is spread across term –deposits of varying maturities. For example, instead of putting Rs 5 lakh in 3-year deposit, one may spread across 1 lakh each in 1-year, 2-year…5-year deposits. What this approach does is to manage the interest rate risk. Laddering also helps in keeping your funds liquid. Higher amount can be put into the deposit offering the highest rate. </div><div> </div><div>In doing so, there is always a re-investment risk associated with any fixed income product of a fixed tenure. But then, predicting interest rate movement is always an impossible tasks even for banks and corporates. Laddering strategy helps in minimizing the risks but cannot be the ideal approach.</div><div> </div><div>Bank FDs. however, are not wealth creators but destroyers. The interest income is fully taxable and interest rates are almost in line with prevailing inflation rate. The real return therefore is low or negative in Bank FD’s. This, however, does not deter investor’s especially retired investors to shun bank FD as they heavily depend on them for their regular income household needs. Laddering will help them avoid the temptation to predict and time the interest rate cycle and instead get the most out of every dip or rise in the rates. </div><div> </div>
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