It is time to invest in short-term debt
Since interest rates are expected to go up, investors should avoid long-term debt instruments or debt funds, reports Sandeep Singh.india Updated: May 27, 2008 21:46 IST
Even though other banks have not confirmed that they will follow State Bank of India (SBI) and raise interest rates, the future is somewhat clear. If SBI, India’s largest bank, raises deposit rates by between 25 and 50 basis points (100 basis points is 1 percentage point) on 2-10 year term deposits to 8.75-9.00 per cent, how can other banks not follow? SBI’s hike also indicates the direction of interest rates over the next three to six months.
If this is the macroeconomic perspective, what should a small investor’s strategy be?
Since interest rates are expected to go up, investors should avoid long-term debt instruments or debt funds. Investing in a long-term debt instrument will see a fall in its value with any rise in interest rate. Also, if the investor locks himself into a long-term debt instrument at this stage, he will miss out on the higher interest rate opportunity that comes his way when the interest rates rise.
“Investor’s should invest in short-term fixed maturity plans (FMPs) of 3-6 months and cash management funds that provide the liquidity to benefit from the opportunity thrown open as a result of a future rise in interest rates,” said Amar Pandit, a Mumbai based financial planner.
Investors should lock into long-term debt funds only once the signals of interest rate peaking come in. “Considering the interest rates to move up from here, long-term debt investment is not attractive and advisable,” said Surya Bhatia, a Delhi-based financial planner. “Stick to 3-6 months FMPs.”
In a rising interest rates scenario, since the cost of investment goes up for companies, their profitability suffers, and hence equity investment does not enjoy the kind of return it enjoys in a low interest rate scenario. “Equity returns are likely to remain under pressure,” said Veer Sardesai, a Pune-based financial planner. “Existing investors can stay put, while new equity investors can go ahead with a staggered approach.” With this approach they will stand to benefit from any fall that the market undergoes.