Fixed deposits rates are on the rise. Though the investors living on interest income are happy about it, they are finding it difficult to catch the peak.
The biggest challenge an investor faces in a rising-rate scenario is to identify the peak and lock in the rates around that level. It is typical for an investor to put his money in a one-year fixed deposit (FD) a couple of months too soon and then repent at leisure when s/he finds one-year fixed deposit available at 75-200 basis points more than what s/he would earn from the old FD. Since FDs do not allow negotiating rates in future, the investors feel trapped in the old FD.
A better way to deal with a rising interest-rate scenario is to invest in floating-rate bond funds that invest in short-term instruments whose interest rates float in sync with benchmark rates. The other option is to invest in liquid-plus funds. Smart investors can start by putting in a good chunk of money in liquidplus funds.
As the rates rise, they keep locking in money in fixed maturity plans (FMPs) at regular intervals. This ensures that the money is deployed at attractive yields and saves you from the risk of missing the peak.
If the rates on the long-term fixed income instruments, such as bonds having a 5-10 year maturity , rise, then the prices of these bonds fall. As prices dip, investors lose money.
Hence, it is better to avoid mutual fund schemes that invest in long-term instruments. Of course, if you are of the opinion that the rates have already peaked on long-term instruments, you may consider investing in long-term funds to earn good returns over the next couple of years.
Equity investors are also not spared by interest rate movements. Interest is the price of one key raw material – money. Hence, when the interest rates rise, the profitability of companies with debt on books goes down.
Investors should avoid interest-rate sensitive sectors such as real estate, automobiles and consumer durables as a large chunk of demand for these goods is satisfied using borrowed funds.