- Date : 15/04/2022
- Read: 4 mins
Having an understanding about the rising rate cycle and the optimum investment options available is the key to manage investments during a rising rate cycle. Learn more about it here.
In simple terms, interest is the cost borne for using someone else’s money. Changes in interest rates usually have a ripple effect over the economy. Though it takes a minimum of 12 months for a change in interest rates to have a widespread impact, the markets respond to the change almost immediately.
Interest rates and security prices
The Reserve Bank of India (RBI), responsible for financial supervision, takes decisions with respect to interest rates to regulate the supply of the Indian rupee.
When the interest rates are decreased by the RBI, borrowing funds becomes attractive. Consumers are left with more money for spending which results in an increase in the revenue and profit of businesses. This enhanced financial performance of businesses leads to higher stock and bond prices. However, the yield on bonds falls. Also, lower interest rates are seen as a blessing in disguise to the economy as investment becomes more lucrative than depositing funds with the bank. However, excess supply of money over a prolonged period of time is likely to result in inflation.
The RBI increases interest rates to curb inflation and ensure stability in economic growth. As the interest rates are increased by the RBI, the cost of borrowing funds increases. This results in the decrease in the money available with the consumers for spending. As the spending money reduces, the businesses take a hit due to reduced revenue and profit. The decline in the financial performance of the businesses pulls down the stock and bond prices. However, as the coupon rates on the bonds remain unchanged, the yield on bonds goes up.
Managing fixed-income investments during rising rate cycle
While fixed deposits may seem to be the easiest way to manage fixed-income during a rising rate cycle, there are a plethora of options available to help you cash in on this opportunity.
It is always advisable to make sure your fixed-income portfolio is diversified during a rising rate cycle. You should try reducing long-term bond exposure and invest in short-term and medium-term bonds as these are less sensitive to increasing rates.
You may want to consider investing in debt funds when the interest rates are increasing as the yields are up and you get better returns on the investment.
Investing in low duration debt-oriented mutual funds could also help you as these capture the momentum of the market by investing in short duration papers.
Besides these, you may also want to take a plunge and invest in equity.
Managing equity investments during rising rate cycle
The fluctuation in interest rates causes volatility in the markets. However, it is unlikely that there would be a decline in the equity markets. The earnings of the companies would continue to grow but at a slower pace.
Investing in stocks of major consumers of raw materials should help you cash in as the price of raw materials are likely to remain unchanged or even decrease. This would result in a higher profit margin of the companies using these materials.
Investing in stocks of healthcare and pharmaceutical companies could also be a good option as people would still need proper health care irrespective of the interest rate fluctuations.
While equity investments might look lucrative, it is advisable to tactically manage your equity investments.
The Bottom Line
Managing your investments could be a tedious task especially during the rising rate cycle as the markets appear to be volatile. However, with an understanding about the opportunities that open up with increase in interest rates, you should be able to manage it just fine. The key is to be aware and open to active, tactical management of investments and to avoid impulsive decisions.