On a physical ladder, you climb step by step to move ahead. In fund management or wealth management, it means matching the maturity of the investments with the time-defined fund requirement. That is to say, when there are defined fund requirements after, say, two years, five years, seven years, etc., if I invest in financial instruments maturing after two years, five years and seven years, I will be doing a laddering of my investments with my financial goals. The advantage of doing this is, when I am matching my investments with my goals, there is no worry about market fluctuations when I need my money. Any investment in market-related securities, even in defensive avenues, is subject to market movements. Hence laddering leads to defensiveness in the portfolio. To be noted, ‘earmarking’ of investments is different from laddering. Investments in equities can be earmarked for particular time-defined fund requirements, but that is only a segregation. When you require the money, the equity market may be booming, which may be an advantage of not laddering. However, if the movement of equity market is not favourable at that point of time, you may be impacted when you liquidate your investments.
How to do it?
Investment in securities maturing as per your requirement of funds leads to perfect laddering. Following up on the earlier example, if you invest in bonds of maturity two years, five years and seven years, you will be laddering your investments. If the horizon is three years, it can be done through a Fixed Maturity Plan (FMP) of three-year maturity. For shorter tenures than three years, it can be done through Interval Plans of Mutual Funds with rollover period matching your horizon, e.g., one year. This part is straightforward. The question here is, if you ladder your entire portfolio, even for long horizons, are you giving up on high-risk, high-return avenues like equity and thereby settling for lower returns? If your horizon is 10 years or 15 years, which is adequate for investment in equity, and if you are laddering your entire portfolio, it would be sub-optimal.
The answer to that is, for long horizons like 10 or 15 years, start with allocation to equity and as you approach your timeline, gradually shift to debt or defined maturity instruments. The shift should be done, not at the last moment, but one to two years prior to the timeline. Thereby, the upside of investment in equity will be availed of, and the stability sought through laddering will also be achieved. There may be a temptation, if the equity market is booming, to remain invested in equity. However, discipline in investments is advisable. In your personal financial planning, return maximisation is one of the objectives, but not the only objective. Volatility minimisation also has to be taken care of.
Matching of the maturity of your investment with your timeline is perfect laddering. The whole idea is to minimise volatility. Moreover, sometimes, the timeline itself is not very clear as life’s events may not be under your control. In such cases, an adequate proportion of your investments should be defensive, even at the cost of relatively lower returns (debt) and the proportion where you are sure there is an adequately long horizon, the allocation should be in aggressive avenues, gunning for higher returns (equity). In quasi laddering, being defensive, you are minimising the potential volatility in your portfolio.
In the planning and implementation of your wealth portfolio, the objective is to meet your financial goals through your savings and investments. The returns in your portfolio has to be optimised, not maximised. Rather than speculate with your life savings for little higher returns, preservation followed by growth should be the priority. Laddering should be given due importance, even at the cost of a little lower returns.
The writer is founder, wiseinvestor.in