FD interest rates: Banks offering the highest interest rates on 1-2 years FDs

Governments world over infused enormous liquidity into the economy during the coronavirus pandemic which has resulted in higher inflation globally. As inflation rises, interest rates are likely to follow suit. When this happens, booking a big FD will lock your investment at a lower rate for a long period. Moreover, if you have an old big FD that was booked say five years ago and is due for renewal, the loss on maturity would be substantial.

Here's some math with an example: Assume you have Rs 3 lakh in hand. Instead of investing it as a lump sum for 3 years, you split it into 3 FDs of a lakh each, the first for 1 year, the second for 2 years and the third for 3 years. You basically invest the cash in 3 different FDs, each maturing a year apart, thus creating a ladder.

At the end of first year, you renew the matured FD for 3 years, creating the next rung. The year after, the FD with the 2-year tenor matures and you reinvest it for 3 years, creating yet another rung. This provides you liquidity at the end of each year. Similarly, one can go for an FD ladder with a 5-year tenure with similar annual intervals.

In a ladder, since you divide the amount into smaller FDs and book them one by one after interval spreading over 3-5 years, from first FD to the last. With such a long gap between the first and last, the chances of your FD earning the lowest rate are substantially lower.

When you go for an FD ladder, you don't have to speculate the interest rate movement to look for a better time to book your FD. It will become time independent as you need to book according to your ladder requirement. This will result in averaging the interest rate movement as some FDs may get booked at lower rates but some will also get booked at higher rates. Though you may not be able book all your FDs at the highest rate but you will still be secured against getting the lowest rate on all your investments due to such time and rate spread.

The rate of interest offered by banks varies across tenures. Usually, the best return of fixed deposit is given on the longer-term FDs, ie. 3-5 years. As the ladder gives you the liquidity at desired intervals, you can still book all your FDs for long-term tenure of 5 years. So despite dividing your big FD into several small FDs, the ladder allows you to go for long-term tenure to get the benefit of higher interest rate of the bank.

One of the unique advantages of an FD ladder is that you get regular liquidity. If you have booked an FD for long tenure and need the money mid-way, you may have to break the FD often at a loss. In a ladder, the amount is divided into small parts with each part maturing at different points in time. It gives you many windows of liquidity without any need of breaking your FDs midway through their tenure.