Term Deposits: What is Laddering and How Does it Work

What is laddering?

Laddering is a strategy that involves an investor dividing their total investment sum and investing each part in separate term deposits with different maturity dates. Each deposit represents a “rung” on the ladder, with each rung having a different maturity date.

For example, let’s say you have $10,000 to invest. Instead of investing the entire amount in a single term deposit, you might choose to create a laddering strategy like this:

• Invest $2000 in a 1-year term deposit.
• Invest $2000 in a 2-year term deposit.
• Invest $2000 in a 3-year term deposit.
• Invest $2000 in a 4-year term deposit.
• Invest $2000 in a 5-year term deposit.

As each term deposit matures, you can choose to reinvest the funds in a new term deposit with the longest maturity or use the funds for other purposes. This laddering strategy helps manage interest rate risk by providing regular access to a portion of the invested funds, allowing for potential reinvestment at different interest rate environments.

What are the benefits of laddering?

The key advantage of laddering is that it provides a balance between liquidity and potentially higher interest rates for longer-term investments. It’s a way to mitigate the risk of locking in funds at a low interest rate for an extended period, while still benefiting from the potentially higher rates associated with longer-term deposits.

What are the risks of laddering?

While laddering can be a great investment strategy, like any financial approach, it comes with its own set of risks. Here are some potential risks associated with laddering:

1. Interest rate risk

Laddering exposes investors to interest rate risk. If interest rates fall significantly, the funds from maturing shorter-term investments may face reinvestment at lower rates, leading to missed opportunities for higher returns. Conversely, if rates rise, longer-term investments may remain locked in at lower rates.

2. Lack of flexibility

While laddering provides some liquidity with regular maturing investments, it can also limit flexibility. If funds are needed unexpectedly, breaking a term deposit before maturity may result in penalties or reduced interest earnings.

3. Inflation risk

Longer-term investments might not keep pace with inflation. If inflation rates exceed the returns on the longer-term deposits, the purchasing power of the invested funds may decrease over time.

How do I start laddering?

Starting a laddering strategy involves careful planning and consideration of your financial goals, risk tolerance, and investment horizon. Here are steps to help you get started with laddering:

1. Define Goals: clearly state your financial objectives, whether short-term or long-term.
2. Assess Risk Tolerance: understand your comfort level with investment risk.
3. Determine Investment Horizon: consider the time frame for achieving your goals.
4. Research Investments: explore other options such as managed funds, KiwiSaver or PIE funds.
5. Diversify Portfolio: spread investments across different assets to reduce risk.
6. Consider Interest Rates: be mindful of the current interest rate environment.
7. Evaluate Credit Quality: assess the credit quality of the bank or deposit taker.
8. Assess Liquidity Needs: ensure your strategy allows for access to funds when needed.
9. Monitor and Adjust: regularly review and adjust your laddering strategy based on changing conditions and goals.
10. If in doubt, consult a Financial Advisor: seek professional advice tailored to your situation.

Remember that laddering is a long-term strategy, and the key is to maintain a balance between liquidity and the potential for higher returns. Stay disciplined in your approach to benefit from the advantages of laddering over time.

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About the author of this page

This report was written by Canstar Content Producer, Caitlin Bingham. Caitlin is an experienced writer whose passion for creativity led her to study communication and journalism. She began her career freelancing as a content writer, before joining the Canstar team.