Personal Finance

Fixed Deposits: Laddering Approach to Gain from Bank Interest Rate Hike

The spike in interest rates since 2022 has added to the attraction of fixed deposits (FDs). For example, the State Bank of India (SBI) was offering an interest rate of 5.5% on FDs, at the moment it is providing an interest rate of about 7.1%. At the same time, various private sector banks are providing interest rates of at least 7.1% on FDs. 

The Reserve Bank of India (RBI) has been in the process of hiking the repo rate by 250 basis points (bps) from May 2022 onwards. In a similar vein, banks have also raised the interest rates of FDs. However, this is at a relatively slower pace. Also, the transmission of deposit rates is not similar across all the FD tenures.

In such a scenario, a prudent move for an investor would be to avoid investing in a single FD scheme altogether. 

An investor is required to select the FD tenure while taking into account the investor horizon and interest rates. For example, the highest interest rate on FD that various banks are currently offering is between one and three years. An investor must, therefore, choose the tenure based on their respective need. 

The laddering approach, which revolves around the idea of dividing investment amounts into several parts, can be adopted in case an investor has no immediate financial need to be addressed and is investing purely to gain from growth in wealth. 

While adopting the laddering approach, an investor is required to invest across different tenures. For instance, for a medium tenure of two-three years, an investor would get better deals in public sector unit (PSU) banks while for long-term FDs with a tenure of five years or above, larger private banks could emerge as a suitable option.

Experts suggest that an investor could consider allocating 50% FD to a short-term FD scheme taking into account the present scenario. The other part could be significantly spread through tenures between one and three years.

Through adopting the laddering strategy in FDs, an investor gains an opportunity to capitalise on significantly higher rates offered at the moment. Also, at the same time they gain from capitalising on potential upside.

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