The recent rate cut by the Reserve Bank of India (RBI) has definitely come as a surprise to many. The industry is now looking forward to a fall in interest rates from here on. As an investor, you can now review your financial plans to make the most of it in this falling interest rate scenario. Let us look at some of the following benefits that one could look forward to in the coming months:
Cheaper loansWhen interest rates fall, borrowers benefit. The central bank has cut the repo rate, the rate at which it lends to commercial banks, by good 25 basis points to 7.75%. Experts note that if banks pass on the benefit of rate cut to borrowers, Equated Monthly Installments or EMIs on floating rate loans will come down. For instance, a home loan with principal of Rs 50 lakh for tenure of 20 years that charges an EMI of Rs 51,609 at 11 percent will now be reduced to Rs 50,761 if the bank reduces its loan rate by 25 basis points to 10.75%. Accordingly, as an investor, you should now approach your bank for lower rates on your home loans. Experts say that you could also look at transferring your loan to another bank, like a public sector bank who can offer you a better rate. Public sector banks are usually prompt in reducing interest rates on loans, thereby passing on the benefit of low interest rates to their customers.
EquityThe stock markets have reacted positively to the recent rate cut and more and more retail investors are entering this space. If you are a first time investor in the stock market, you too could look at taking the plunge but stay invested for the long term. It is advisable to buy quality stocks across different sectors. Do not get lured by market tips, especially by putting your money on those penny stocks that are moving up due to the overall benchmark indices.
Tax-free bondsIf you are an investor in the highest tax bracket of 30.9 percent, you could buy tax free bonds from the secondary market with a yield of around 7 percent. Experts say that these bonds can offer better tax adjusted returns to investors, as compared with other fixed income instruments like fixed deposits, high rated company deposits and small saving schemes. These bonds can offer capital appreciation to investors in addition to the interest paid on the bonds, as interest rates are poised to fall further. Investors can enjoy better tax treatment on capital gains which is taxed at 10.3 percent if they hold on to these bonds for a period of one year.
Fixed depositsIf we look at the current scenario, banks have already reduced their deposit rates, even before the central bank announced a rate cut. In the coming months as interest rates are expected to slide, leading to a fall in the loan and deposit rates, experts suggest that investors should park their money for the long term, by opting for three and five year fixed deposits. Those investors who are keen on investing in fixed deposits and wish to park a lumpsum of say Rs 3 lakh, could look at having three different fixed deposits of Rs one lakh each, which could be partially withdrawn in case there is an emergency. If you are keen on investing in a low risk tax saving instrument, you could look at a five year tax saving bank deposit that will offer you an interest rate of around 8.75-9 percent.
Fixed maturity plansExperts note that if you are not a risk taker, you could look at opting for three and five year fixed maturity plans. Ideally, these schemes can help you to park your funds for the next three or five years. Accrued capital gains on three years’ time will attract tax at 20 percent with indexation, which is even better than paying tax at 30.9 percent on fixed deposit interest. But then, if you cannot hold on to these investments till maturity, its best to avoid them.
BondsIn a falling interest rate scenario, you can always opt for long duration funds like mutual fund schemes that invest in long term bonds issued by the government and corporates. When interest rates fall, prices of bonds go up. As long term bonds are more sensitive to interest rate changes, they will offer high capital appreciation as compared to a short term bond. Experts note that here you will have to keep track of interest rates, and move your funds out of these long duration funds when interest rates bottom out.
Market participants are expecting interest rates to go down by 50-75 basis points in this calendar year. The RBI governor has made it clear in his statement that once the monetary policy stance shifts, subsequent policy actions will be consistent with this stance. So, one can expect benign interest rates for at least the next six months to a year. Investors can take a closer look at their portfolios and align themselves to benefit from the rate cut cycle.
