The human mind is essentially selfish and complains about anything and everything that even remotely affects its interest. The reduction in rates which were announced yesterday, brought this point home to me with a great deal of clarity. Anyone with a smattering a knowledge of economics and business would have known that such rate cuts were inevitable. Yest when the actual announcement came the Electronic media and social media treated this as a full scale catastrophe and even something that would cause ruination of the middle class. My advice to all such people will be – “Stop the scare mongering, wake up and smell the coffee.”
Why do I say that the interest rate reductions were inevitable and should have been something any reasonably intelligent investor should have anticipated? Consider the following indicators of the economy over the last 1 year and more:-
- Inflation headline numbers have been coming down progressively and is roughly in line with the targets that the government had set. Yes, we can argue that the CPI figures do not reflect the real situation etc but those are the figures used in policy making by the government.
- Based on the inflation numbers the RBI has already made several rate cuts and a couple of more cuts may be in the offing in 2016.
- Deposit rates in the banks have already been reduced over the last year. SBI rates are below 7.5% even today and private banks are also not offering more than 8%.
- Tax free bonds which were at 9% in earlier years were being offered at 7.69% at the higher end from all companies that brought them to the market this year.
- Based on all of these, it would simply not have been possible for the government to continue the artificially high rates in the Small Savings Schemes. These rates have to be aligned to the real economy, the government cannot prop these up by subsidies.
Having understood this, let us now focus on what can be done. Firstly, at a conceptual level we simply have to understand that these rates will now get linked to the markets. So in the given context it is quite possible that there may well be a further downward revision in the rates over the next one year or so. However, as the inflation comes down the real rate of return will hopefully increase and therefore the investor is not necessarily any worse off. Secondly, it is not the responsibility of the government to prop up the rates artificially by subsidizing the interest rates. We must look at these products as something the government is selling and make our own decisions as to whether we want to invest in these or not.It is our money and our decision, there will be very little point in blaming the government if the rates continue to go lower because of the economy and business context.
For people who are retired and depend on these schemes and others for a regular income, they can lock in their money into POMIS and SCSS even now to avail of the higher rates of interest. Both the lock ins will be fairly long term at their age profile and therefore they must be sure about not needing the capital in an emergency situation. People having PPF can continue to withdraw from it, though the rates will be lower. For such people fresh investments can simply be the minimum to keep the account running.
What about the rest of the people who are having a debt portfolio, not with a view to earn a regular income but to grow it as part of retirement corpus in future. I an outlining overall strategies for a variety of instruments, choose your options based on your need and attitude.
- PF is a must for all salaried people and they can additionally have PPF. Till the EEE structure of PPF undergoes a change this is the best debt product.
- Professionals and business people should have PPF accounts for themselves and their spouses – try to contribute the maximum amount permitted.
- People blessed with a daughter must contribute in SSY. Given the nature and purpose of the product SSY will always have a higher interest rate compared to other products.
- Debt MF of the category Liquid funds and MIP do not make much sense now and are best avoided for most investors.
- Short term debt funds are likely to have higher returns in the medium term due the interest rates declining further but they do represent some credit risk. Additionally with the rise in the Cost Inflation Index becoming tempered due to lower inflation numbers, some tax impact will be there even after indexation.
- FMP will still be a good idea if you are OK with 7-8% returns, but the time window will probably be only the next 1 month or so.
- Tax free bonds are probably now over for this year but, if NHAI does come up with one more scheme, definitely invest in it. For people in the 30% tax bracket, the pre tax yield is in double digits and no product gives you so much today. This is particularly applicable to people who have a need for regular income.
- Avoid products like Hybrid funds and Gilt funds if you do not understand them.
- Finally if you have some risk appetite go with Equity Saving funds and Arbitrage funds for some fresh investments.
In conclusion, while you do need to reassess your investments and maybe tinker with a few things, there is no need for large scale panic and significant overhaul of your portfolio.
In the next post I will outline my own strategies for tackling the current situation.