The Reserve Bank of India last week slashed the repo rates by 25 basis points to 6 percent in its third bi-monthly monetary policy review. While loan borrowers are likely to reap the benefits of the repo rate cut of 25 basis points with a possible reduction in their loan EMIs, investors especially those relying on bank Fixed Deposits are likely to face challenging times with reduced deposit rates.
If you are also a conservative investor or someone relying largely on bank Fixed Deposits or Recurring Deposit for your investments, here is how the repo rate cut can impact you and some possible alternatives to ensure minimal impact on your investment:
An overview of the repo rate cut
A repo rate is a rate at which banks borrow money from the Reserve Bank of India. On the other hand, the reverse repo rate is the rate at which banks park their surplus funds with the RBI. The RBI has cut the repo rate by 25 basis points to 6% from 6.25%, while the reverse repo rates have come down to 5.75%. With CPI inflation remaining below the 4% mark, the repo rates have reached a seven-year low.
Many economic experts suggest that although the repo rates may not witness any immediate additional rate cut, a good monsoon followed by an under-control retail inflation can set the tone for another rate cut before the end of the financial year. As an investor, it is therefore important for you to keep a track on the inflation to ensure you are aware of any impending future rate cuts.
Options for a conservative retail investor
As a retail investor focusing on traditional investment options like Fixed Deposits, a repo rate cut means lower deposit rates. With the reduction in bank FD and Recurring Deposit rates, here are some realistic options for you as an investor:
Opt for a laddering approach
A good way to ensure dropping Fixed Deposit rates leave a minimal impact, opt for a laddering approach of investment. Instead of having one big Fixed Deposit of a single tenure, opt for smaller deposits of varying tenure. With different maturity amounts and different tenures, such a laddering approach can offer you enough liquidity. When a bank FD of shortest tenure gets matured, you can renew it again for the longest tenure and so on adopting a fully operational laddering approach towards investment.
Lock in Fixed Deposits at current rates for a long term
If you are not worried about liquidity and looking at a purely safe investment option, it may be a good idea to seek a long-term deposit. Locking in your bank FD for a 5-year tax saving option can ensure optimum investment. With experts not ruling out further rate cuts, a long term lock-in period is advisable provided you have a financial plan in place, ensuring the investment stays put for the entire tenure.
Diversify investments in debt Mutual Funds
In a falling interest rate scenario, it is a good idea to opt for investing in debt funds. The returns offered by debt funds are inversely proportional to the interest rates offering decent returns with a lower risk compared to the equity market.
So, a debt fund’s Net Asset Value (NAV) gains when interest rates fall and vice versa. Debt funds offer both dividend and growth options and therefore are suitable even for those looking for a periodic regular income for their financial needs. There are various types of debt funds that you can choose as per your investment horizon. For short term investments, liquid funds are a good option. Long term investors can make use of intermediate bond funds or dynamic bond funds.
With repo rate at seven years low now, investors should look at various options to ensure that the lower rates do not impact both their short- and long-term investments.
(The writer is CEO, BankBazaar.com)