Did you know - Falling interest rates can be great investment opportunity?
BLURB: Investing in fixed return products? Then the falling interest rates might give you a sleepless night. Invest in debt mutual funds that has an ability to do well in both falling and rising interest rate scenario.
Our earlier generation or you may call them as baby boomers always had a huge fetish about the fixed return or guaranteed return traditional debt products. Products like fixed deposits, Bonds, National Savings Certificate (NSC), Post office deposits, Public Provident Fund (PPF), etc formed major part of the portfolio of our earlier generation. Talk to them of other investment products and they would feel wary about it and might give you 10 reasons why they are fine investing in them even today. This would be the story of most of our households and thus it has become an integral part of even our investment culture!
But what’s wrong with these products, if they have been around for so long and have given stable returns over the years? This is a question that many millennials like us get to listen from their parents, isn’t it?
Let’s dig deeper to understand why we millennials need to look for different products and move ahead of this traditional product culture.
Recently I met my friend Akash after a long time at a coffee shop. He is a happy-go-lucky chap who likes to live life on his terms. But that day he looked a bit stressed and I could sense that! Sipping up the coffee, I asked him about what was the matter that is bothering him. That’s when he told me about his retired father who was tensed as his interest income and the only source of income i.e. from the deposits and other savings got shrunk lately due to the falling interest rates. His father was the only bread-winner for the family and in the current scenario he was finding difficult to meet the day-to-day expenses. Akash was finding difficult to help him in that situation as he had just completed his graduation and was too looking out for a job.
Being a Financial Planner, I told him that like most Indians, his father was risk averse and preferred assured return traditional products since they offer guaranteed interest & capital protection. But they are ignorant to the fact that these products do not help beat inflation and attract higher taxes which impact the overall return from the investment. While these products may get negatively impacted in the falling interest rate scenario.
But what if I were to tell you that falling interest rates can actually be a great investment opportunity?
This instantly grabbed Akashs’ attention. Being curious to know he started to engage further. He asked, “What is it?”
“It’s Debt Mutual Funds”, I said.
Debt mutual funds invest in diversified portfolio and invest across fixed income market which includes money market securities such as commercial papers, treasury bills, certificate of deposits, etc; government securities market and corporate bond market. As the underlying securities are traded in the market, the value fluctuates depending on the liquidity and the direction of interest rate. When interest rates rises, the value of the bonds fall and when rates fall, the inverse happens. Thus, when RBI cuts interest rate, the value of the debt fund investment is expected to increase and earn a higher return.
There are different types of debt mutual funds and the fund manager invest in instruments keeping in mind the investment objective of the scheme, investment time frame and risk-reward framework of the fund.
Unlike traditional assured return products, debt funds offer a wider variety. You can invest even for a day in a liquid scheme. For a period between 3 months to 1 year, you have short term funds. These are considered a good alternative to savings bank account as they come with low risk, are highly liquid and offer relatively stable returns. You can consider short-term bond funds for a 1-3 year horizon like Credit Opportunity Funds, Corporate Bond Funds, etc. For medium and long term period i.e. 3-5 years, invest in funds like Gilt Fund, Dynamic Bond Fund, Income funds, etc.
On taxation part, debt funds held for less than 3 years are added to your income and taxed as per your income slab. There is no penalty* or TDS on these funds unlike traditional products. While, if held for more than 3 yrs debt funds are taxed at 20% irrespective of tax slab with indexation that helps reducing the taxable amount by adjusting gains against inflation from the time you bought the asset to the time you sell it. Due to a lower tax on investments, the debt funds tend to provide better post-tax return as compared to traditional assured return products.
*Certain debt funds attract exit load if redeemed before stipulated period.
Akash finally had a smile on his face as he understood how debts mutual funds were better alternative to traditional assured return products and now would be help his father. He was able to gradually shift his father’s entire investments to different Debt Mutual Funds and helped him get regular cash withdrawals via systematic withdrawal plans (SWP).
Now if you meet any such baby boomers, help them to plan their investments better!