Laddering

Put a whole retirement corpus into bonds maturing in the same year and two things go wrong. You are locked into one interest rate. And the money all arrives at once, in a year you may not need it.

Laddering fixes both. Instead of buying securities that all come due in the same year, you buy bonds or fixed deposits maturing at different dates.

The workbook calls it one of the effective strategies to create a good retirement income.

Each rung matures in turn. You reinvest it at the longest end of the ladder and the shape of the ladder stays the same. So every year something matures and something is reinvested.

That gives two benefits the workbook names for bonds: managing interest rate risk, and managing cash flow.

It works the same way with bank deposits, and there it is easier to see.

Goal one: managing interest rate risk. Bonds are most affected by interest rate movements. Put most of the money into bonds maturing in the same year and you have locked in a single interest rate. The workbook says the investor tends to lose money when rates rise a few years later.

A ladder works in both directions:

Goal two: managing cash flow. Many bonds pay interest twice a year. Structuring maturities across different periods spreads those interest payments across different months or years, which generates regular income. The ladder also gives the flexibility to reinvest the principal as each rung comes due.

The mechanics, in the workbook's own bond illustration. Mr B has USD 500,000 to invest in fixed income. He divides it into 5 investments of USD 100,000 each, maturing in 1, 2, 3, 4 and 5 years.

Starting today, USD 100,000 matures every year. He takes that money and reinvests it in the bond at the longest end of the ladder. What was two years away is now one year away; what was five years away is now four. The rung he just bought sits at five years. The ladder is kept intact.

Note that this illustration is in US dollars and is credited to an external source, not to an Indian market example. The rupee illustration is the fixed deposit one below.

The fixed deposit version. Mr C wants to invest Rs 10 lakh. Under the FD laddering technique he breaks the corpus into five equal parts of Rs 2 lakh each, in 1-year, 2-year, 3-year, 4-year and 5-year deposits. As each matures he reinvests it in a new 5-year FD.

So the 1-year FD matures and, reinvested for five more years, comes due in year 6. The 2-year FD comes due in year 7. The 3-year in year 8, and so on. The workbook calls the result an investment loop with enough liquidity to meet a financial requirement every year.

The two benefits it names for FDs: the investments are less impacted by interest rate fluctuations in the long term, and most of the funds stay secure and can be used separately in times of need. It adds one refinement: different banks can be used for different rungs, diversifying the investment as well.

The workbook's own rupee case. Mr C has Rs 10,00,000 and wants annual liquidity in retirement.

From year 1 onwards, Rs 2,00,000 becomes available every single year, without breaking a single deposit.

Now compare the alternative. Had Mr C put the whole Rs 10,00,000 into one 5-year deposit at, say, 7%, he would have nothing liquid until year 5. If he needed money in year 2 he would have to break the deposit and face what the workbook elsewhere calls clawback of interest paid and a pre-mature redemption penalty.

And the rate effect. Suppose deposit rates rise from 7% to 9% in year 3. With the ladder, the rungs maturing in years 3, 4 and 5 are reinvested at 9%. On the Rs 6,00,000 involved, that is Rs 12,000 a year of extra interest against the 7% he was locked into. Had rates instead fallen to 5%, the rungs bought earlier would keep paying 7% until they came due.

The refinement the workbook suggests. Spread the five rungs across different banks. Mr C then also diversifies credit exposure across five institutions while keeping the same annual liquidity — the workbook's own point that one can choose different banks for different rungs for better earnings.

Chapter 5 (Retirement Products), section 5.3.3 — Laddering of Bonds or Fixed Deposits — sits inside the distribution-stage products discussion, after annuities and before the Senior Citizens' Savings Scheme. It carries both worked illustrations.

Expect the two goals of a bond ladder (managing interest rate risk and managing cash flow), the mechanism question (the maturing rung is reinvested at the longest end), and the Mr C arithmetic — Rs 10 lakh split into five Rs 2 lakh deposits of 1 to 5 years, each rolled into a fresh 5-year FD. The two named FD benefits are also clean recall: less affected by rate fluctuation in the long term, and funds stay secure and separately usable.

• The maturing rung is reinvested at the longest end of the ladder, not the shortest. Reinvesting short would collapse the ladder within a few years.
• Laddering manages interest rate risk; it does not remove it. In a falling-rate environment the maturing money still has to be reinvested lower. What the ladder prevents is having the whole corpus exposed to one rate.
• The two stated goals are interest rate risk and cash flow. Higher return is not one of them, and a ladder will usually yield less than a single long bond in a rising yield curve.
• The bond illustration is in US dollars. Only the fixed deposit illustration is in rupees, and the workbook credits the bond example to an external source.
• Five rungs is the illustration, not a rule. The workbook sets no required number of rungs and no minimum amount per rung.
• A ladder is not a bucket strategy. A ladder staggers maturities within fixed income; a bucket approach splits the corpus across asset classes by time horizon.
• It does not avoid the tax on interest. Deposit and bond interest remains taxable as it accrues or is received, whatever the maturity pattern.