Interest rates

How to Navigate Higher Interest Rates

Ouday Dhoot: Essentially, mutual funds buy interest-bearing bond securities. The basic principle of any type of bond investment is that when interest rates rise, bond prices fall; and when interest rates fall, bond prices rise. Basically, the interest rate and bond prices are inversely related.

Since mutual funds, unlike fixed deposits, must be valued daily, the net asset value is determined based on how bond securities are valued. So if interest rates rise, bond prices will fall. To this extent, the net asset values ​​of debt mutual funds will decline.

Within the debt category, there are different types of mutual funds. There are so-called overnight funds and there are long-term G-Sec funds.

A mutual fund’s interest rate risk, which is basically how violently the mutual fund’s net asset value will react to movements in interest, is essentially a function of duration. The longer the duration of the underlying debt security or mutual fund you hold, the greater the price impact will be when interest rates rise. The shorter the duration, the lower the risk. So if interest rates rise, debt funds are likely to experience temporary negative returns – and the temporary is an important element here.

This impact may not be seen in overnight funds, money market funds, because they hold very low duration securities that mature very quickly.

If a fixed deposit has been listed, its price will continue to rise and fall as interest rates move. But if you hold the fixed deposit until maturity and the company repays the principal and interest, you will still get what you were promised when you entered into this investment. The same will happen with the debt security you hold in your investments.

When we talk about existing investments, it is an investment that could have been made maybe six months, a year or three years ago.

You need to think about your portfolio and decide what kind of decision to make: how long have you held these investments? What is your investment horizon? What is your tax status – what tax bracket do you belong to? What is the underlying debt portfolio that you hold?

Let’s say you expect interest rates to rise, and to that extent, debt fund yields are likely to temporarily turn negative. What should you do? Ideally, you would want to exit this fund and invest in another fund that will not react or be affected in the same way.

But each time you exit a debt fund, you will have to pay capital gains tax. If you hold the debt fund for less than 36 months, you end up paying taxes according to your tax bracket.

Let’s say you earned a 5% or 6% return on a debt fund today; he did not complete the 36-month window. You go out and pay almost a third if you’re in the highest tax bracket. Basically, 2% disappears directly as tax. Is it still wise for you to move? Maybe not. Maybe you’re okay with living through this volatility for a while and staying invested.

Map your investment horizon with the type of debt fund you have: what is your holding period? How long will it be before it becomes long term and then make a decision.

Generally, if you hold rollover programs, target maturity debt funds, floating rate funds, ultra-short duration funds – and if your investment horizon matches what you pulled – and obviously overnight in money market funds, so there may not be a need to make any changes.

But if you hold funds for a long time and want to get away from volatility for a while, maybe if the tax impact is very low, you want to get out and come back.