Be a Prudent Investor by Keeping an Eye on Interest Rates

The first thing that strikes our mind when we go for that big ticket purchase is of course the interest rate on the loan lent by banks or financial institutions. Higher interest rates translate into higher Equated Monthly Installments (EMIs), tighter monthly budgets and lower savings. It just explains why the interest rate is more prominently displayed in brochures screaming out new loan schemes launched by banks and financial institutions.

So it’s obvious that lower interest rates enable individuals to save more and invest in financial instruments of their choice. Well, now how many times do we go for big ticket purchases? At the most a house or two or a couple of cars in one’s lifetime (if we exclude the High Net Worth Individuals). So do we really have to constantly track interest rates? A discerning investor in all probability will do that. Let me tell you why.

Interest rate is a key weapon used by the American Federal Reserve (the Fed) and other similar central banks around the world such as the Reserve Bank of India for controlling inflation. During periods of high inflation, central banks increase repo rates (the rate at which central banks lend money to retail banks) to curtail borrowing. The retail banks in turn pass over the higher interest rates to individual customers and companies by increasing interest rates on home loans, car loans, business loans and credit cards among others. With the increase in value of currency, people and companies curb their expenditure, which in turn translates into lower demand and softening of inflation. The positive side to this increase is that banks and governments increase the interest rate on deposits and bonds (read national savings certificate). So, it’s good news for depositors.   

Effect on Companies and Stock Markets

As interest rates increase, the valuations of companies fall as companies find it harder to borrow money, expand their operations and increase profits. And with the parallel increase in fixed deposit rates and bond rates, the stock market naturally becomes less lucrative for investors who then generally opt for the much safer debt instruments (such as fixed deposits and bonds) over the stock markets. This in turn leads to less cash flow in the stock markets and lower returns from them.

However, interest rate is only one of the many factors that influence the stock market and one cannot for sure say that a rise in interest rate will negatively impact the stock markets.

Why You Can Make Money in the Stock Market

My entry into the world of equities was anything but sane. Armed with knowledge obtained from a pocket-sized guide book on mutual funds I thought I was all set to enter the stock market of all the things in this world. All the hype around the Indian economy and stock market in 2007 made me more crazy about stocks. I followed the guide closely which advised readers on buying newly launched mutual funds (also known as New Fund Offers) as the Net Asset Value (NAV) would be less. I then got caught by this infrastructure craze that was going around the Indian markets then with news channels and stock market pundits going gaga about the government’s massive plans of investing and developing the much ignored infrastructure in India. 

The first New Fund Offer that caught my attention was Birla Sunlife International Equity Plan. As per the documents, this fund would invest primarily in equities both in India and abroad. Without second thoughts I invested money in it. Next I invested in Kotak Indo-World Infrastructure Fund, TATA Indo-Global Infrastructure Fund and finally Sundaram Energy Opportunities Fund. Well, now it must be very clear to you how much crazed I was about infrastructure being the next big thing in our country.

It did not take long for me to take massive hits. Talks about the sub-prime crisis started soon after and within six months my investments in all funds were reduced to less than half. Of the above only Birla Sunlife International Equity fund gave me some hope as its NAV was not as bad as the others. The other three just melted faster than a vanilla ice cream in your mouth. What did I do? I just waited and waited with a hope that things would revive. Meanwhile, I started buying individual stocks on the advice of the stock broker I signed up with. I made some profits and losses. For example, stock values of Balrampur Chini and Deccan Chronicle plunged faster than a shark diving in an ocean in search of its prey. While I just sold off my holdings in Balrampur Chini for a massive loss, I continue to hold Deccan Chronicle hoping for some miracle in distant future. I did comfort myself on the losses I made on Balrampur Chini thinking that “Had I spent the same money on some shirt or shoe or restaurant, it would have been nothing now”. Well the reasoning is not that excellent but some solace nonetheless.

Coming back to my investments in mutual funds, the Indian stock market showed signs of improvement around 2-3 years ago. Kotak merged Kotak Indo-World Infrastructure Fund with a much better performing Kotak Select Focus Fund and Sundaram merged Sundaram Energy Opportunities Fund with Sundaram Infrastructure Advantage Fund. One fine day, I went to TATA mutual funds office and asked the executives there to suggest a better performing fund. On the advice of one executive, I switched over to TATA balanced fund. Today, nearly 7 years later, I see that I have about average returns on all the mutual funds.

If a total dummy like me can realize profits in the stock market so can you. But I do have some advice based on my experience.

1.       Never ever expect quick and fantastic returns in the stock market

2.       Patience is the key

3.       Word for dummies “Mutual Funds are better options than trading on your own”

4.       If someone has made a killing in the stock market don’t jump into the bandwagon. What works out for somebody will not in all probability work out for you

Hope my article will help out someone somewhere….