The most anticipated event of the year, the Union budget, has just ended, leaving people with the eternal questions: what’s in it for me? Does it impact my life? Does this have an impact on my wallet? Although the stock market took it well, the average investor did not find good news; in fact, she left worried.
The past two years have been extraordinarily difficult for the country. The economy needed all the support and stimuli it could get to generate a better growth rate than yesterday to get back on track. Globally, all central banks were borrowing at near-zero rates and giving them to the public at near-zero rates. Just like the Reserve Bank of India. He also borrowed cheaper and gave money at cheaper rates, especially during the waves of Covid.
It’s been going on for a long time. Do you remember the amount of money that entered the system due to demonetization? When supply increases, prices fall. When a large amount of money is available in bank accounts, fixed deposit (FD) rates crash because banks have more money than they need, so why pay high interest. Overall, this is a long-term trend. A one-year fixed deposit is now at 5%. After inflation and taxes, most of the time it will be negative net returns. But few people consider this when they have return insurance.
A saver becomes an investor
Given the low yields, the saver has turned into an investor, with increased risk, duration and returns in her portfolio. Today, the proliferation and awareness of equities as an asset class, especially through Systematic Investment Plans (SIPs), is increasing every month. However, debt and equity markets do not work the same way. Debt has a different structure of rising and falling yields.
Simply put, if interest rates fall, long-term funds perform well, as they did in 2019-20. Over the past two years, interest rates have been low around the world, so people and businesses have been able to borrow, consume and sell at low rates. The cycle is now reversed. The free money in the world has almost achieved its goal of generating growth. This growth is now heading towards inflation. To fight inflation, central banks reduce money flows and thus make money expensive, which will cause interest rates to rise. If governments make money expensive, so will others down the chain.
In the budget, the Indian government said it wants to borrow Rs 14.9 lakh crore in the financial year 2022-23. As he borrows more from the market, he reduces the money for others. So others who need money have to pay more for it. For example, a bank that needed money for three months was paying 3.6% interest per annum in December 2021. Today, it has to pay 4.1% for the same term. If you were to lend to such a bank, you would earn 50 basis points more. Sounds good, right? It may seem good today, but if you had given the money in December 2021, you would feel a little bad now.
It’s time for low duration funds
So how do you decide where to invest? You can invest in funds that capture that upside, which liquid, short duration, and ultra-short mutual funds do. They invest in short-term paper that can capture this rise. When interest rates rise, these funds move faster into these high-yielding, lower-duration securities.
In equities, market movements and returns mostly go in the same direction. In debt, it’s the opposite, so difficult to understand.
You make decent returns when interest rates go down. Imagine investing in an FD bank at 7%. After six months, imagine the banks giving 5% on the same FD. If you could sell this fixed deposit, you would get a bonus. The reverse would have happened if current DF rates were 8% or higher. If you don’t mind, you still get 7% back on your FD.
In debt funds, invest when returns rise because you get a better rate to invest. Invest in a fund closest to your holding period. Stay invested to get returns as close to your holding period as possible. In the meantime, if interest rates rise, buy more if you can. If interest rates go down, you will get a bonus. If nothing else, if you stay invested until the end of the document and get the return shown.
In equity investments, investors are not confused by their past investment rate or value. Today’s rate is an entry point for them. The same can be done for debt investments, if investors can ignore past rates and invest in the rising rate scenario and wait for the interest rate cycle to unfold.
Debt can also give good returns and can be better planned. All it takes is a little hat thinking.
The author is Head – Product and Strategy Communication, Mirae Asset Investment Managers (India)
(Disclaimer: The views expressed are those of the author and Outlook Money does not necessarily endorse them. Outlook Money will not be liable for any damages caused to any person/organization directly or indirectly.)