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The State Bank of India's decision to raise deposit rates has put many investors in a fix, as it comes at a time when everyone was expecting interest rates to come down.
Obviously, investors are asking a few questions aloud: Is this the right time to book or renew fixed deposits, particularly of longer-term maturities? Or, should I wait for a further increase in rates? Also, what should the strategy be for debt mutual funds? The answers, investment experts will aver, depend on your risk profile, return expectations, requirements and goals.
However, here are a few broad hints that may offer you some clues:
Fixed Deposits
As you know, the interest rates on FDs are indeed reigning high at the moment. So, if you are looking to invest in fixed deposits, you need not think twice. However, what you need to ponder over is the tenure of your investment. Many banks offer better rates for fixed deposits with terms of around 1-2 years vis-à-vis those with tenures of over 3-5 years. Consequently, individuals are inclined towards booking deposits with shorter maturities. For, not only do they fetch higher returns but also mature sooner. However, as of now, several banks are offering almost identical rates for deposits with tenures of 1-2 years as well as 3-5 years. For instance, SBI promises a rate of 9% per annum for both these maturities. Even in cases of banks that don't, the difference is around 25-50 basis points.
And that raises the question: Should you lock into longer tenure deposits, especially if you do not need the funds in the next 3-5 years? Or is it better to adopt a wait-and-watch policy and settle for shorter term deposits instead? After all, the deposits can always be renewed later. However, what this line of thought ignores is the reinvestment risk. Simply put, the current rates may not be available to you when your FD is to be renewed. Individuals should look at a longer tenure if they are interested in locking in money and have no near-term requirements. Interest, rates will be lower after one year when your FDs come up for renewal.
Now, experts continue to expect the rates to moderate in the medium term. We believe interest rates in India have peaked and expect them to be stable/ benign going forward. Given the trend of inflation, RBI may not cut interest rates very aggressively; however, the contracting economy may force the central bank to cut rates in the near future. Also, the slow pace of deposit growth has forced banks, like SBI, to raise deposit rates so as to maintain a balanced credit deposit ratio. It is more likely that interest rates would cool down in the medium to longer-term. If the rates do fall, you can do little except regretting your decision to play it safe.
Short Term Bond Funds
A high interest rate scenario means higher returns from liquid, ultra-short term or short-term debt mutual funds. What's more, they are tax-efficient as compared to fixed deposits. The flipside, of course, is that they are riskier too. Therefore, the decision will hinge on your risk appetite and the time you are willing to commit. Short-term bond funds and fixed maturity plans can be attractive options given that current 1-2 year yields on bonds are roughly 10%. If an investor wants to invest for the short term, then a liquid or an ultra short bond fund will make for a good. If you have money lying idle in your savings bank account that earns you a return of 4-7%, you may consider moving these into a liquid fund or ultra-short-term fund. If the economy goes through the high interest rate scenario, it makes sense to invest in liquid funds and short-term funds. However, as the interest rate settles down, liquid funds would be quick to fall in line with market's interest rates, and accordingly, returns will fall too. Short-term funds are a good proposition for an investment horizon of 1-2 years in all interest rate cycles, irrespective of the interest rate movement.
Long Term Debt Funds
The other instrument that reacts to interest rates is the long-term bond fund category. Unlike fixed deposits as well as liquid and short-term debt funds, the decision-making could be more complex here.
This is a tricky space to invest in at present, as interest rates are not easing as fast as one would have expected them to. Everyone is expecting RBI to reduce interest rates to help kick-start the economy, but RBI has not done so given that the inflation is still stubbornly high and the central bank would rather have the government kick-start the economy via policy measures.
Several attributes influence this space, resulting in ambiguity on expected returns. Given that there is still a fair bit of uncertainty on that (interest rate movement) front, investors would do well to adopt a cautious stance on long-term bond funds for now.
If you are investment-savvy, you can even look at putting your money in all the debt instruments. Instead of locking the investments at one point of the yield curve, it makes sense to stagger investments across the yield curve. Also, they can look at investing across FDs, corporate bonds and debt funds. Investing in long-dated gilt funds is another option that must be explored.
Investors could look at a combination of accrual-based short-term funds as also actively managed long-duration funds to potentially capitalise on the current yield curve structure
Happy Investing!!
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