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Why existing liquidity may be a good idea in the face of likely rising interest rates

Why existing liquidity may be a good idea in the face of likely rising interest rates

If inflation is forecast to be around 5.3% for the rest of the year, investors cannot ignore real rates: the nominal rate minus inflation.

In the case of a one-year time deposit with a deposit of around 5%, the real interest rate is negative. After-tax performance looks worse. While long-term bond rates may be a bit higher, there is no point in staying stuck as rates are likely to rise. Even if you are satisfied with current returns and want to hold your investments to maturity, volatility can arise when interest rates rise.

Impact if you stay invested in very short-term ways

Investment options in cash or very short-term in fixed income securities seem safe if you think interest rates are going to rise. The strategy here is: wait for interest rates to rise, then switch from short-term investments to 1-3-year time deposits or short-term pension funds.

The same occurs with cash, where the portfolio’s return to maturity is 3.6%, while a short-term fund has a 4.9% return and medium-term funds 5.9%. If you invest in cash rather than in a fund for the short or medium term, you will get low returns. Investors with a long enough holding period should not continue to invest in cash just because interest rates are likely to rise.

A rating previously issued by the IDFC Mutual Fund recommends investing in government bonds for the medium term. The spread between one-month interest rates and six-year government bonds is 255 basis points compared to a five-year historical average of 139 basis points. A basis point is one hundredth of a percentage point.

Investors trying to synchronize the market by staying on the short end of the yield curve and planning to invest their money in duration products after the rate hike are missing out on the potential yields on medium duration bonds (4-6 years). and accumulated earnings.



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