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How Rising Interest Rates Impact Your Investments—and What You Should Do About It

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How Rising Interest Rates Impact Your Investments—and What You Should Do About It
November 14, 2024

Table of Content

 

The investment risk of ULIP is borne by the policyholder. 

As a senior professional in India, you have probably noticed the financial landscape shifting around you. You have worked hard to build a stable nest egg, and with retirement on the horizon, you might be wondering how the current economic conditions—especially rising interest rates—will affect your investments.

Interest rates are at their highest in years, and while this might benefit savings in some cases, it also brings potential challenges to certain types of investments. Understanding how these changes impact your portfolio is essential to safeguarding your financial future.

Interest Rate Trends in India

In the past two years, the Reserve Bank of India (RBI) has been on a rate-tightening path, driven by the need to control inflation. Beginning in early 2022, the RBI increased the repo rate from around 4% to 6.5% by 2023. After that, its been a pause as of October 2024*. Overall, rates have gone up 250 basis points. This shift has been significant, especially for an economy that had grown accustomed to lower rates in the previous decade.

Rising interest rates primarily aim to control inflation, which is crucial for protecting purchasing power. By increasing rates, the RBI seeks to curb excessive spending, thereby slowing down inflation. This is particularly important for senior professionals, as high inflation erodes the value of savings over time. With stable purchasing power, your investments retain more of their real value, ensuring you’re better positioned for long-term financial security.

The latest RBI update indicates potential rate cuts on the horizon as early as December 2024+. This cautious stance reflects the RBI’s focus on balancing inflation control with economic stability. For Indian investors, especially those nearing retirement, these rate adjustments influence everything from fixed deposits and bonds to equity markets. This environment calls for a thoughtful approach to re-evaluating your investment strategy.

Impact on Different Investments

Fixed Income Instruments: Higher interest rates tend to improve the yields on new fixed deposits (FDs) and bonds, which can benefit conservative investors seeking stability. For instance, five-year fixed deposit rates, which hovered around 5.5% in 2022, have climbed to around 7-7.5% today^. This increase provides a more attractive option for those looking to secure guaranteed returns, especially in the run-up to retirement. However, for existing bondholders with older, lower-rate bonds, there may be some decline in the market value of those bonds, as new bonds with higher yields are now available.

Example: If you invested in a fixed deposit at 5.5% in 2022, the return would be significantly lower compared to a new FD today at 7.5%. For every ₹10 lakh invested, the annual interest now yields ₹75,000, compared to ₹55,000 previously. This increased income can make a difference for those relying on interest for regular expenses.

Equities: Rising interest rates often lead to increased market volatility, impacting stock prices and equity investments. Higher rates raise borrowing costs for companies, potentially reducing profits and dampening stock market performance. This trend was observed during the recent rate hike cycle, with the Nifty 50 index experiencing periods of volatility. Of course, interest rate cuts can boost prospects of equities.

For experienced investors in mid 40s and 50s, heavily exposed to equities, this can be a concern, as market dips may affect the overall value of their portfolios. At the same time, equities still offer potential growth over the long term. So, maintaining some exposure to them can be beneficial. The key is balance—ensuring that your portfolio isn’t overly dependent on equities but retains enough to benefit from long-term growth trends.

Strategies to Protect and Grow Your Investments

With interest rates remaining high and potential cuts in sight, it’s a good time to revisit and perhaps rebalance your portfolio to align with your changing financial needs. Here are some strategies to consider.

1. Protect Your Wealth with Smart Choices: Annuities and ULIPs

In a high-rate environment, investments that offer fixed returns, such as annuities or retirement plans, become more attractive. Annuities, for example, provide a steady income stream, which can be valuable for retirees seeking stability. HDFC Life offers annuity plans with guaranteed income options that can help safeguard your finances from market fluctuations, providing predictable returns as you transition to retirement. These plans are especially beneficial for those looking to avoid market risks while securing their income.

Additionally, ULIPs (Unit Linked Insurance Plans) can be a good addition for those looking to balance growth with stability. They offer life cover and potential tax benefits1helping you grow wealth tax-efficiently.

2. Optimise Your Portfolio for Any Market: Blend Stability with Growth

Given the volatility in equity markets, now is an opportune time to assess your asset allocation. While equities are valuable for long-term growth, consider adjusting your portfolio to include more fixed-income investments to take advantage of higher rates. Diversification remains essential; having a mix of assets can help cushion against downturns in any one category.

For instance, with current FD and bond yields higher, you might consider shifting a portion of your equity holdings into these options to lock in better rates. Maintaining a balanced portfolio with a combination of fixed-income, equities, and possibly ULIPs allows you to navigate both high-rate periods and potential market shifts.

If rate cuts happen, the landscape for fixed-income and equity investments changes. If interest rates decrease, new fixed-income investments (like FDs and bonds) offer lower returns. If you have locked in higher rates beforehand, you benefit, as your returns remain unaffected by the rate cut. However, for future investments, lower rates mean reduced income from these instruments. In such times, equities often become more attractive and potentially driving stock prices up.

Maintaining a balanced portfolio—fixed income for stability, equities for growth, and ULIPs for tax benefits and life cover would be a smart move. They will allow you to adapt to both high- and low-rate environments, ensuring resilience regardless of economic shifts.

Conclusion

The economic environment is constantly evolving, and with interest rates at their highest levels in years, now is the perfect time to reassess your investment strategy. For senior professionals looking toward retirement, stable income options like annuities and retirement plans offer the security you need, while ULIPs provide a balance of growth and life cover with tax benefits. Keeping a diversified portfolio that aligns with current rates can help you preserve and grow your wealth.

For instance, HDFC Life offers a range of investment options designed to meet varying risk profiles, including annuities and ULIPs, helping you secure a steady income and build wealth tax-efficiently. Staying informed about interest rate trends and adjusting your portfolio as needed can ensure a financially sound future as you approach retirement.

Source:

*See table: https://www.reuters.com/markets/rates-bonds/india-cenbank-holds-rates-expected-shifts-stance-neutral-2024-10-09/

+ https://www.livemint.com/economy/rbi-may-cut-repo-rate-by-25-bps-to-6-25-in-december-say-economists-volatile-food-prices-remain-a-worry-11730300773849.html

^ https://www.bankbazaar.com/fixed-deposit/5years-fd-interest-rates.html

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ARN: ED/11/24/17793

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Francis Rodrigues Francis Rodrigues

Francis Rodrigues has a decade long experience in the insurance sector, and as SVP, E-Commerce and Digital Marketing, HDFC Life, manages the online sales channel, as well as digital and performance marketing. He has had hands-on experience in setting up sales channels and functional teams from scratch over a career spanning 2 decades.

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Vishal Subharwal Vishal Subharwal

Vishal Subharwal heads the Strategy, Marketing, E-Commerce, Digital Business & Sustainability initiatives at HDFC Life. He is responsible for crafting and ensuring successful implementation of the overall organisation strategy.

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Unit Linked Insurance products do not offer any liquidity during the first five years of the contract. The policyholders will not be able to surrender/withdraw the monies invested in Unit Linked Insurance Products completely or partially till the end of fifth year.

Unit Linked Life Insurance products are different from the traditional insurance products and are subject to the risk factors. The premium paid in Unit Linked Life Insurance policies are subject to investment risks associated with capital markets and the NAVs of the units may go up or down based on the performance of fund and factors influencing the capital market and the insured is responsible for his/her decisions. 

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