Step-up SIPs and FD laddering: How to maximise your investment potential with balanced approach

New Delhi: Investors often explore different investment avenues, hoping to find a route that gives momentum to their investment journey. With varied preferences, goals, and risk appetites, investors go for different investment products. These products might be market-linked or offer interest rates fixed by the financial institution. Depending on the source of returns, risks associated with these tools also differ.

Market-linked products such as mutual funds carry market risks, while Fixed Deposits (FDs) offer relatively predictable returns at predetermined interest rates.

People often assume the only way to get higher returns is to invest large sums, which might hold true. However, it must be understood that wealth creation can also be achieved with a systematic approach and discipline. Even if one needs to invest a higher amount, it can be done gradually throughout the years.

There are ways available to those who have an appetite for market risks and for those who do not.

Step-up SIP

A regular SIP involves investing a fixed amount at regular intervals, often monthly, in mutual funds. However, there is a provision to widen the scope of gains by increasing this regular contribution every year. This method of investment is called a Step-up SIP, which can accelerate wealth creation as income grows.

A Step-up SIP allows investors to increase the investment amount by a fixed percentage at a fixed interval. This increase can also be automated through an auto step-up facility.

Take two examples: In Case 1, the monthly investment is Rs 5,000, with an assumed annual return of 12 percent and an investment period of 15 years. With a total investment of Rs 9 lakhs over 15 years, the returns would amount to Rs 16,22,880, building a corpus of Rs 25,22,880.

In Case 2, the investment amount is increased annually by 10 percent, making the total investment Rs 19,06,349. This would lead to returns of Rs 24,35,576. Thus, the corpus generated would be Rs 43,41,925. The wealth generated in the two scenarios differs significantly due to the annual increase in investment, which also raises the total amount invested over the period.

However, the actual wealth generated may vary, as annual returns depend on the stock market, which keeps fluctuating. Step-up SIPs are not free from risks, since the money goes into the stock market, which does not offer guaranteed returns. Moreover, they require an income that can support the increase in the investment amount; otherwise, the SIP may create a burden on the investor.

FD laddering

A person chooses an FD to keep some money aside for different purposes while getting relatively predictable returns on it. Choosing a single FD to put away all your money may not be the best option since it may lock in the entire amount in one place, restricting liquidity and limiting flexibility.

The corpus would grow as per the interest rate applicable under that particular FD. Therefore, one may consider FD laddering to distribute savings across different maturity periods and improve access to funds.

FD laddering is a strategy which includes dividing the corpus into portions that go into multiple FDs with different tenures and applicable interest rates. It enables liquidity of funds through different maturity periods, without having to break the entire deposit and withdraw the entire sum. While one of the FDs matures, others remain invested and continue generating interest.

Breaking the deposit prematurely may be the only option when there is an urgent need for money but the entire amount is invested in a single FD. This may disrupt the person's savings and investment plans and could also attract a premature withdrawal penalty, depending on the bank's terms and conditions.

Suppose an investor has a sum of Rs 5,00,000 to invest, which can be divided into 1-year, 2-year, and 3-year FDs. They may allocate the lump sum across these tenures:

-- Rs 1 lakh: 1-year FD
-- Rs 2 lakh: 2-year FD
-- Rs 2 lakh: 3-year FD

Alternatively, FDs with short maturity periods of a quarter or 6 months can be chosen if the money is needed for a near-term goal.

-- Rs 1 lakh: 6-month FD
-- Rs 1 lakh: 1-year FD
-- Rs 1 lakh: 2-year FD
-- Rs 2 lakh: 3-year FD