What to do Intrest rates are going down ?

So you quickly repaid a big part of your home loan because the interest rates went up did you? Welcome to the world of fluctuating interest rates!

Interest rates play an important role in your personal finances. The RBI tries to raise or lower key interest rates that trickle down and affects everything - from your housing equated monthly installment (EMI) to the interest rates on your savings bank account.

As rates begin to fall, what should you do?

Accept that experts also only guess!

First of all it is necessary to understand that interest rates are a function of inflation, interest rates in other countries, money supply, government spending, government policy, demand and supply of money - from businesses and households, etc.

Even for experts being able to predict the US meltdown, the slowing down of growth in Asia, Brazil, etc. is not really easy. So generally they take a 2-3 month view - which is not useful when you are planning investments for the next few decades!

Planning for interest rate changes requires that you understand why RBI makes these decisions in the first place. In a democracy (in an election year that too!) governments are particularly sensitive to inflation. So the RBI is pressurized to reduce inflation - by sucking our liquidity in the market. Interest rates increase in an effort to make borrowing money less-attractive and slow a rapidly growing economy. Exactly the reverse is done to make the economy go faster! Lowering the rate will make money flow more freely and hopefully stimulate economic growth.

Not always a blessing!

When interest rates go down, there is a sense of happiness amongst the consumers. Please remember you are a producer too! Decreasing interest rates is normally in response to a slowing economy. As we have seen the last few months have not been kind to anybody`s portfolio. All asset classes have done badly - we are only measuring how badly. If somebody told you cash is king, well it is because the others are paupers! Remember somewhere in your family your father, father-in-law, mother etc. are worried about lower bank interest rates.

Your strategy does not change!

Will you buy a bigger car because petrol prices have come down by Rs 5 a liter? Exactly so for your interest rates coming down. If you have a lot of debt, tackle the highest interest rate loans first. It still makes sense to cut down on loans. Especially if you realize that last years` bonus figure is now in the history books. If your HR does not call you to ``discuss`` a voluntary separation, treat that as a bonus! A rate change by RBI does not automatically reduce your interest rates.

Call your bank and ensure that your housing loan, credit cards, personal loans, etc. are all charged at a lower rate. A consumer is no longer the king unless he/she is well informed! Also realize ``we will get back to you``, ``we are examining your requests`` are all nice answers which actually does not reduce your debt! Try refinancing your loans if you must. Act tough - a few ``reputed`` organizations need more than a nudge to change!

Floaters rejoice!

For those who are looking to buy an asset (on borrowed money), or those on a floating rate already, decreasing rates is certainly a good thing. While housing EMI rates aren`t directly linked to RBI`s rate cuts, the signaling surely helps. Of course, do not get carried away and buy a house much bigger than what you actually need. Even those of you who have kept your savings in floating rate funds are now getting a higher return on your monies. If you already own a home and purchased it when the rates were a bit higher, this could be an opportunity to refinance. Even being able to reduce your borrowings by One point of interest can make a lot of difference, in the total price that your asset!

What about your savings?

Clearly, low interest rates are great for borrowing money, but when it comes to trying to earn money on your savings, it isn`t to your advantage. However, if you have invested in HDFC Prudence or Templeton India Pension Plan, the debt portion would have appreciated in the last couple of weeks - a falling interest rate regime is benign for older portfolios. However, it will not happen continuously unless the interest rates keep falling. If your bank fixed deposit rates are dropping you should quickly tie-up for 18-36 months. Banks are as likely to reduce fixed deposits as they have done on home loans. You could perhaps look at some Income funds - with a 2-3 year view! Instead of a savings account, you should look at a floater fund or a liquid fund if you are not sure of how long you want to keep the monies there - Income funds have an exit load! Also remember dividend distribution tax, short term capital gains tax and income tax while dealing with savings. Investments on the other hand are more tax efficient. My IRIS.

Read the full post...

FMP or FD. Confused ??

By number of funds as well as money invested, one of the most important type of mutual fund in India is something that is generally called a Fixed Maturity Plan. Of the 1920 mutual funds that are currently available, no fewer than 805 are FMPs, as they are known. And of the Rs 5.61 lakh crore that is invested in Indian mutual funds today, 68,000 crore is in FMPs. FMPs are generally used by companies and large investors as an alternative to bank fixed deposits. In general, these funds resemble FDs more than they do other mutual funds. These are closed-end funds, meaning that one can only enter them when they are launched and exit them when their pre-stated term is over. Actually, one can exit them earlier, but generally after paying a load that is high enough to be a serious discouragement. More importantly, fund companies offer an ‘indicative return’ for FMPs. Unlike other types of mutual funds, FMPs are run in such a way that this indicative return actually has some meaning.

FMPs invest in debt instruments with the intent of holding them to maturity. This means that regardless of any ups and downs in the market value of the investments, the final earnings are predictable. Therefore, the indicative returns that FMPs provide to investors reflect the reality.

One obvious question is why investors should prefer FMPs to bank deposits. The reason is mostly to do with tax efficiency. When you put money in a fixed deposit, the interest gets added to your income. In FMPs longer than a year, if you elect to take all your gains as capital appreciation, the taxation is merely 10 per cent with indexation benefit or 20 per cent with indexation. That’s generally quite a saving from the tax rate which either individuals or companies would pay on the interest earned from a bank deposit.

Even for investments less than a year, there’s a tax advantage if the investor takes the option of receiving the gains in the form of dividends. In this case, individual investors will get taxed at 12.5 per cent of the returns and corporates will get taxed at 20 per cent. This is the dividend distribution tax that is deducted by the fund company. Once this is paid, no further taxation applies to the income. Although this is obviously not as much of a tax advantage as the long-term capital gains option, it’s still a lot lower than the full tax payable on bank deposits.

The only question that remains is if they are as safe as bank deposits. In theory, they aren’t. Like any other mutual funds (and unlike banks), you could lose all your money in an FMPs. In practice, FMPs have been predictable and safe.

However, to enhance the overall yield FMPs may assume high credit risk and run the risk of default. Nowadays, the increasingly tight liquidity and credit situation could mean that some of the companies in which FMPs invest could be sailing closer to the edge than earlier. There’s plenty of talk about how some real estate companies are facing tough times. If an FMP has invested in such a company’s debt, the chances of an FMP returning less than the indicated yield or even turning in a capital loss cannot be ruled out completely.

Generally speaking, FMPs invest in high quality instruments, which have been rated by at least one credit rating agency. In case of investment in unrated papers, prior approval of the board of directors of the AMC or the Trustee has to be obtained. All things considered, even though FMPs are generally seen as something that only companies invest in, there’s no reason why individuals should not use them as more tax-efficient fixed deposits.

Read the full post...