Ladder your fixed deposits to avoid the risk of reinvestment: Experts

Debt fund investors should keep the bulk of their investments in shorter-duration funds, 10-20% in longer-duration ones

On August 5, the Reserve Bank of India (RBI) hiked the benchmark repo rate by 50 basis points (bps). It now stands at 5.4 per cent. Altogether, the RBI has hiked the repo rate by 140 bps in this cycle. Most economists expect the repo rate to rise to 5.75-6 per cent by the end of this calendar year. Fixed deposit (FD) and debt mutual fund (MF) investors need to calibrate their strategies for a rising-rate scenario.

FD rates rising with a lag
 

While FD rates have risen, the pace has been slow.

“The transmission of the increase in repo rate to FDs has been much slower than the transmission to lending rates. Leading private- and public-sector banks have increased their FD rates by around 30-50 basis points (bps) since the May monetary policy committee meeting,” says Naveen Kukreja, chief executive officer (CEO) and co-founder, PaisaBazaar.

All banks have raised their deposit rates in the past few months.

“More increases in deposit rates are likely in the coming weeks after the latest repo rate hike. However, these may be staggered to prevent escalation in the cost of funds,” says Adhil Shetty, CEO, BankBazaar.

Investors starting FDs now should opt for shorter tenures, so that they can roll them over into higher-rate deposits when the former mature.

“They should also avoid the auto-renewal facility while booking FDs,” says Kukreja.

Doing so will allow investors to renew their FDs at the best rates after factoring in their investment horizon and the highest slab rate available.

Trying to guess the best time to lock into long-term FDs is an exercise in futility. You may think interest rates have peaked, but they could move up further.

Lovaii Navlakhi, board member, Association of Registered Investment Advisers, says, “Create a ladder of maturities — invest in FDs maturing at different times. This will minimise the risk of reinvestment.”

Laddering will also ensure cash flows at regular intervals.

Excessive reliance on FDs must be avoided.

“Returns from bank FDs are negative when one accounts for both inflation and tax. Unless FD returns are at least a few percentage points higher than inflation, they won’t be attractive,” says Shetty.

An investor may, he says, opt for FDs for short-term capital protection, say, to park emergency funds.

Investors must factor in the impact of taxation.

“The return will be different for someone in the highest tax bracket vis-à-vis someone below the basic exemption limit,” says Navlakhi.

Avoid excess risk in debt MFs  
 

With interest rates on the upswing (the 10-year government security is currently trading at around 7.3 per cent), yields-to-maturity of debt MF portfolios have improved.

“An investor constructing his portfolio should put 10 per cent into liquid funds to meet his emergency needs. Another 30-40 per cent could be put in a shorter-duration fund, such as a money market fund, which is currently offering 6-6.5 per cent — about 150-bp higher than a liquid fund. 
 

You may also invest in a short-duration fund or a banking and public sector undertaking roll-down fund, which will give a yield of 7 per cent. The final 10-20 per cent could be invested in longer-duration funds, in case inflation falls and the bond market rallies,” says Sandeep Bagla, CEO, TRUST MF.