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Fixed income investment helps to bring in stability in one’s portfolio by minimising market risks associated with riskier investments like stocks. If handled smartly, fixed income investment can also help you in meeting your periodic cash flow requirements and can help to meet you medium and long term financial goals.

One way of investing smartly in fixed income instruments is by ‘laddering’ your investments. By laddering, instead of investing all your money for one term, you invest that money for varying tenures in parts.

Let us understand this through an example. Suppose you plan to invest Rs 40 lakh in debt. Instead of investing the entire Rs 40 lakh that you have in five-year fixed deposits, you invest Rs 10 lakh each for 1, 3 ,5 and 7 years tenure. You may either want to invest in fixed deposits or other instruments such as non-convertible debentures (NCDs) or National Saving Certificates (NSC) if tenures of the instrument in question match and your financial goals permit you to do so.

“Laddering means matching the tenure of your investment goal/cash flow requirement with the maturity of fixed income investments,” explained Joydeep Sen, Corporate Trainer (Debt markets) and author.

While investing in bond funds, you may want to invest in bond funds, duration of which matches with your intended holding period. For example you may want to invest in a mix of low-duration fund (duration of 6-12 months), short-duration fund (duration of less than three years) and medium-duration fund (duration of 4-7 years).

Helps meet liquidity requirements

When you are investing in line with your financial goals, you cannot ignore intermittent liquidity requirements even if you may have an emergency fund in place. If you have bonds or fixed deposits maturing at various points in time, you can handle your finances better. Also, each time you get the maturity proceeds of fixed deposits or bonds, the same can be redeployed for similar terms again if the cash is not required at that moment of time.

“Laddering helps you to manage your liquidity requirements in an efficient way. You can do this by investing in combination of debt mutual fund, ETF, Deep Discount Bonds (DDB), Tax free Bonds or Taxable NCDs,” said Vikram Dalal,  Managing Director, Synergee Capital Services.

You can further fragment it if you are investing in fixed deposit. For example, instead of making fixed deposits of Rs 10 lakh each for each of the tenures mentioned above, make five fixed deposits of Rs 2 lakh each.

Minimises interest rate risks

When you are investing in bond funds, keeping all the money invested in a single tenure does not help. For example, if an investor invests all his money in liquid funds to avoid interest rate risk, then he or she will have to settle for low accrual income. If an investor invests all his money in long-term bonds looking at high accrual income (in the form of high yield to maturity compared to liquid funds), then he is expected to take interest rate risk. When interest rates go up quickly, the bond prices fall leading to losses in long duration funds.

If you have invested in various baskets such as liquid, short, medium and long duration funds and hold your investments for the same time frame of the duration of the funds, then you are less likely to face interest rate risk. “One of the major benefits of laddering is minimising interest rate risk. On maturity, the proceeds come from the issuer of the instrument, not from sale in the secondary market,” Sen pointed out.

Reduces reinvestment risk

If all the money you invested in fixed deposit matures at the bottom of an interest rate cycle, then you will redeploy that at low rates. Locking in all your money at that point in time is a big risk. But, when you ladder your debt investments, your maturities are also spread out. This ensures that you invest across interest rate cycles. And reinvestment risk gets curtailed.

In addition to healthy risk-adjusted returns, laddering in fixed income can give you peace of mind – which is far more important for low risk investors.