5 Ways to Benefit from Higher Interest Rates

EMIs are rising across the board as RBI has started raising the benchmark interest rate. It is doing this to control inflation by reducing demand in the economy.

Higher interest rates lead to higher EMIs. This reduces people’s expenditure on almost everything. This lowers the overall demand for goods and services in the economy. Low demand brings down prices.

This is good news for the entire economy. After all, high inflation affects all of us by reducing our purchasing power.

But it causes pain in the short term.

It’s not just high EMIs. Lower expenses mean less revenue for businesses. This can result in lower wages for employees and fewer orders for suppliers.

Higher interest rates also affected stock prices. This is because shares are valued based on their future profits. Specifically, what are those benefits worth today.

It is calculated with the help of ‘Risk Free Interest Rate’. This is usually the interest rate on the benchmark government bond. The higher the rate, the lower the value of future profits. This puts pressure on the share prices.

So what can you do with your money? Where should you invest when interest rates are rising?

Here are 5 options…

Fixed deposit

This is the most logical option and is the most commonly used option.

Banks and financial companies have been offering high interest rates on deposits. This is a good opportunity for those seeking the security of fixed income.

Since 2020, interest rates have been low but fixed deposit rates have been rising recently.

If you are looking to deposit a higher amount in a fixed deposit, you should keep in mind that the interest rates are likely to rise even higher.

Hence, consider diversifying your fixed deposits to take advantage of higher interest rates.

sovereign bond

The Government of India now allows retail investors to invest in sovereign bonds.

In November 2021, RBI launched the Retail Direct Scheme. Under this scheme you can open an online ‘Retail Direct Gilt Account’ and start investing in Government of India Bonds immediately.

With this account, you have access to both the primary market (buying government securities directly from RBI) and the secondary market (buying from other investors at the prevailing market price).

Thus, as a retail investor, you will be able to invest in Government of India Treasury Bills, Central Government Bonds, State Government Bonds, State Development Loans (SDLs), and Sovereign Gold Bonds (SGBs).

There is no charge for opening and maintaining an RDG account with RBI. You only need to pay a nominal payment gateway fee while trading in government securities.

corporate debentures

Like the government and financial institutions, corporates too need credit.

They can take loans from banks for their projects but they are aware of the fact that interest rates are rising.

Thus, they will try to raise funds from retail investors as well. They can do this by issuing debentures. These are fixed income securities that are secured against a company’s fixed assets, such as plant and machinery.

Corporate debentures may offer higher interest rates than bank FDs and government bonds but they do not provide the security of both.

They come with credit ratings issued by rating agencies. However, it is up to the investor whether he wants to believe these ratings or not. This is because rating agencies do not have a good reputation when it comes to warning investors about possible defaults.

Stocks of companies with pricing power (and less debt)

Why are we discussing stocks in this editorial?

Well, there is a category of companies in the market which is different from the rest. Not that their share prices are free from high interest rates. But they are flexible.

These are companies with pricing power. By this we mean companies able to pass on the cost escalation due to inflation to their customers.

In other words, their customers are paying for higher input prices. This ensures stable margins for these companies. And this steady profit and dividend payout.

What does this have to do with high interest rates?

Well, central banks increase rates to control inflation. Thus companies that cannot raise prices face lower margins. They also suffer from high interest rates if they have debt on their books. As a result, these stocks have risen.

On the other hand, if a company can manage inflation on its own, and doesn’t have much debt (or is debt-free) then its stock is largely protected from crash.

If purchased at a fair valuation, these stocks could be yours Multibagger stock for next 10 years.

Sleep

This may seem like an odd choice.

falling gold price And for good reasons. High interest rates provide a good option for investors seeking security with some return on investment.

Since gold does not pay interest, its price comes under pressure when interest rates rise around the world.

But this is the ideal time to invest in gold.

After all, what better chance for long term investors to buy gold at a good price?

The recent correction in gold provides one such opportunity. Intelligent investors can buy gold wisely.

Once the interest rate cycle turns down again, gold will be the biggest beneficiary.

Disclaimer: This article is for informational purposes only. This is not a stock recommendation and should not be treated as such.

This article is syndicated from equitymaster.com