- This is how you can invest your money when interest rates are rising.
Do you have a home loan or a car loan? If yes, then you would have already felt the pain of rising EMIs.
EMIs are rising across the board because the RBI has begun raising the benchmark interest rate. It’s doing so to control inflation by reducing demand in the economy.
Higher interest rates leads to higher EMIs. This reduces spending by people on almost everything else. This reduces the overall demand for goods and services in the economy. The lower demand brings down prices.
This is good news for the economy as a whole. After all, high inflation affects us all by reducing our purchasing power.
But it does cause pain in the short term.
It’s not just the higher EMIs. Reduced spending means lower revenue for businesses. This could result in lower salaries for employees and fewer orders for suppliers.
High interest rates also hurt stock prices. This is because stocks are valued on the basis of their future profits. Specifically, what those profits are worth today.
This is calculated with the help of the ‘risk-free interest rate’. This is usually the interest rate on the benchmark government bond. Higher the rate, lower is the value of the future profits. This puts pressure on stock prices.
So what can you do with you money? Where should you invest when interest rates are rising?
Here are 5 options…
Fixed Deposits
This is the most logical choice and the one most commonly used.
Banks and financial companies have been offering higher interest rates on deposits. This is a good opportunity for those seeking the safety of fixed income.
Since 2020, interest rates have been low but fixed deposits rates have been going up recently.
If you are thinking of committing higher amounts to fixed deposits, you should keep in mind that interest rates are likely to go up even more.
So consider spacing out your fixed deposits to take advantage of higher interest rates.
Sovereign Bonds
The government of India now allows retail investors to invest in sovereign bonds.
In November 2021, the RBI launched the Retail Direct Scheme. Under this scheme you can open an online ‘Retail Direct Gilt Account’ and start investing in GoI bonds right away.
With this account, you have access to both the primary market (buying G-secs directly from the RBI) and the secondary market (buy from other investors at the prevailing market price).
Thus, as a retail investor, you will be able to invest in GOI treasury bills, central government bonds, state government bonds, state development loans (SDLs), and sovereign gold bonds (SGB).
There are no fees to open and maintain the RDG Account with RBI. All you require to pay is a nominal payment gateway fee while trading in G-secs.
Corporate Debentures
Just like the government and financial institutions, corporates also have need of credit.
They can take loans from banks to fund their projects but they are aware of the fact that interest rates are going up.
Thus, they will look to raise funds from retail investors too. They can do this by issuing debentures. These are fixed income securities which are secured against fixed assets of a company, like plant and machinery.
Corporate debentures can offer higher interest rates than bank FDs and government bonds but they do not offer the safety of either.
They do come with credit ratings issued by rating agencies. However, it’s up to the investor to decide if he/she wants to believe these ratings. This is because rating agencies don’t have a great reputation when it comes to warning investors about a possible default.
Stocks of Companies with Pricing Power (and Low Debt)
Why are we discussing stocks in this editorial?
Well, there is a category of companies in the market that are different from the rest. It’s not that their stock prices are immune to higher interest rates. But they are resilient.
These are companies with pricing power. By that we mean companies capable of passing on cost increases, due to inflation, to their customers.
In other words, their customers are paying for the higher input prices. This ensures stable margins for these companies. And this stable profits and dividend payouts.
What does this have to do with higher interest rates?
Well, central banks hike rates to control inflation. Thus companies that can’t increase prices, suffer from lower margins. They also suffer from high interest rates if they have debt on their books. Thus, these stocks get hammered.
On the other hand, if a company can manage inflation on its own, and doesn’t have much debt (or is debt free) then its stock is insulated from a crash to a large extent.
If bought at a reasonable valuation, these stocks could be your multibagger stocks for next 10 years.
Gold
This might seem like an odd choice.
The gold price is falling and with good reasons. Higher interest rates offer a good alternative to investors seeking safety along with some return on investment.
As gold doesn’t pay an interest, its price tends to come under pressure when interest rates are going up all around the world.
But this is the ideal time to invest in gold.
After all, what better opportunity do long-term investors have to buy gold at a great price?
The recent correction in gold offers just such an opportunity. Intelligent investors would do well to buy gold in a prudent manner.
Once the interest rate cycle turns down again, gold will be the biggest beneficiary.
Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.
This article is syndicated from Equitymaster.com
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