Laddering and reinvestment risk

A deposit is often described as risk-free. It is free of one risk and fully exposed to another, and this chapter is about the one that remains.

The two risks, separated

The Fixed income subject drew this distinction for bonds and it applies unchanged here.

Price risk is the risk that the instrument's value falls when rates rise. A deposit has none: it is not marked to market, and you are repaid the agreed amount.

Reinvestment risk is the risk that when the money comes back, the rate available is worse. A deposit has this in full, and removing price risk is exactly what creates it — because being repaid at par on a fixed date means you must find a new home at whatever rate then exists.

So "risk-free" is a claim about price, smuggled into a conversation about outcomes. A five-year deposit at 7% followed by five years at 5% produces a different ten-year result from ten years at 7%, and nothing about the safety of either deposit protects you from that.

The evidence that this is not hypothetical

The administered PPF rate is the cleanest long series available, and it shows what a long-horizon saver has actually faced.

Period	PPF rate
1986-87 to 1998-99	12.0%
01.03.2001 to 28.02.2002	9.5%
01.03.2003 to 30.11.2011	8.0%
01.04.2016 to 30.09.2016	8.1%
01.04.2020 onward	7.1%

Someone who began saving in the early 1990s at 12% and kept saving has watched the rate on each new rupee fall by nearly five percentage points. No deposit defaulted and nothing was mismanaged; the reinvestment rate simply moved, and it moved in one direction for three decades.

That is reinvestment risk realised over a working life, and it is the strongest argument in this subject against treating deposits as a complete plan.

What a ladder does

A ladder splits an amount across several maturities — say five equal tranches maturing in one, two, three, four and five years. As each matures you reinvest it at the longest rung, so after the first five years you hold five deposits each of five-year tenor, with one maturing every year.

What it achieves:

It spreads the reinvestment decision across time. Instead of one date on which the entire sum is re-rated, you re-rate a fifth of it each year. No single year's rate environment determines your outcome.

It creates annual liquidity without breaking anything. One rung matures every year, so predictable needs are met at par — which matters because chapter 2 showed that breaking a deposit early re-rates the whole holding to the period actually held rather than merely charging a penalty.

It averages the rate you earn. Over time your portfolio rate is the average of the last five years' five-year rates, which is smoother than any single rate.

What it does not achieve, and is often claimed to:

It does not remove reinvestment risk. If rates fall and stay low, every rung reinvests lower and your portfolio rate converges on the new, lower level. The ladder changes the speed at which you arrive there, not the destination. The PPF table above would have hurt a ladder too — more slowly, and by the same amount in the end.

It does not beat a correct rate forecast. If you knew rates would fall, locking everything long today would win. A ladder's value is entirely that you do not know.

Working the problem

₹10,00,000 needed in no part for five years.

One five-year deposit. You contract today's five-year rate for the whole amount and make no reinvestment decisions at all for five years. Your five-year outcome is known today with certainty.

A five-rung annual ladder. ₹2,00,000 each at one through five years. Over the five years you make four reinvestment decisions, at rates you cannot see yet.

Which wins, by rate path:

Rate path over the five years	Winner	Why
Rates fall	Single five-year deposit	You locked the high rate on everything; the ladder reinvests its short rungs lower
Rates rise	Ladder	Maturing rungs are reinvested at better rates; the single deposit is stuck
Rates flat	Roughly a tie	The ladder gives up a little to the normally higher long rate
Rates volatile but end where they started	Ladder, slightly	Averaging across several reinvestment dates avoids being wrong on one date

Which I would choose not knowing the path. For a genuine five-year horizon with no interim need, the single five-year deposit, and the reason is specific: over this particular horizon the ladder's main benefit does not apply.

A ladder's two real advantages are interim liquidity and avoiding a single reinvestment date. The problem states no part of the money is needed for five years, so the first is worth nothing. And the single deposit has no reinvestment date inside the horizon at all — it matures exactly when the money is needed, so there is nothing to spread. Matching the deposit's maturity to the need removes reinvestment risk over the holding period entirely, which is the strongest form of the protection a ladder only approximates.

The ladder becomes right the moment the premise weakens — if the five-year horizon is an estimate rather than a fact, if some of the money might be needed in year two, or if this is a continuing pool rather than a sum with a deadline. For an emergency buffer or a retiree's income pool, the ladder is clearly correct, because for those the horizon never ends and liquidity is the point.

The general rule this illustrates: match maturity to need where the need has a date; ladder where it does not. Laddering is the right answer to an open-ended horizon, not a universally superior structure.

Where the RBI rules bite

Two provisions from chapter 2 shape ladder design.

Rates may vary only by tenor, bulk size or the absence of premature withdrawal. So you cannot negotiate a better rate for bringing a large laddered portfolio to one bank — splitting across banks costs you nothing in rate, and chapter 1 showed it gains you deposit insurance cover.

Premature withdrawal is re-rated, not merely penalised. This is the quantitative case for the ladder: the cost of being forced to break a long deposit is larger than people expect, so paying a small amount of yield for scheduled access is usually worth it when access might be needed.

The point

A deposit removes price risk and in doing so creates reinvestment risk in full, which is why "risk-free" describes the price rather than the outcome. The administered PPF rate falling from 12% in the 1990s to 7.1% since 2020 is that risk realised over a working life with nothing going wrong. A ladder spreads the reinvestment decision across years, supplies annual liquidity without triggering the re-rating that breaking a deposit causes, and averages the rate earned — but it does not remove the risk or beat a correct forecast. Where a need has a date, match the maturity to it; ladder only when the horizon is open-ended.