Using this technique used in the investment world, an investor to an extent can get rid-off two of the grave risks associated with investments such as the liquidity risk as well as the re-investment risk, as you never can be sure about the financial environment when your proceeds mature.
So in all the technique involves buying a set of financial products such that they mature at different times. It can also be the case when you stagger your investments by investing in only a single product say FD for instance and these mature at different time.
When talking about the technique, as in the case of a ladder, each of the rung signifies the investment with a particular maturity date and the height is the difference between the investment of a higher maturity date and lower. A proper laddering calls for some 10 rungs so as to enable proper diversification such that the investment yields stable return with an overall higher average yield.
Two major benefits of laddering
Liquidity ease is offered in laddering and capital can be freed up as and when there arises a requirement or you can say this way that you can spread out your investments targeting your different short and long term goals. For short term goals, you can look at investments with a shorter maturity while in case of goals that are far ahead, you can look at products with a more maturity term to get a more favorable return.
Re-investment risk all at once can also be get rid off: In an instance when all of your investments mature at the same time, there can be case when the interest rate regime is abruptly down and now you fail to chalk out the proper investment product to channelize your funds.
So, to make a sound investment decision, you need to diversify your investment not only in respect of the products that make your overall portfolio but also across maturities. This can be better understood with an example, say if you are a low risk appetite investor and have a surplus to invest of Rs. 5 lakh, then a prudent strategy will be to not make a FD of Rs. 5 lakh, instead go for 5 deposits of Rs. 1 lakh each with maturity of one, three and 5 years. And if at all you need funds or happen to liquidate them, you do not break the entire FD of Rs. 5 lakh and instead as per the requirement can prematurely withdraw funds from the investment.
Experts thus suggest to build your portfolio at varying points of time and build a financial ladder instead as per your financial goals.