5 ways to take advantage of higher interest rates

EMIs are increasing across the board because the RBI has started raising the benchmark interest rate. It does this to control inflation by reducing demand in the economy.

Higher interest rates result in higher EMIs. This reduces people’s expenses for almost everything else. This reduces the overall demand for goods and services in the economy. Falling demand drives prices down.

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

But it causes short-term pain.

It’s not just the higher EMIs. Reduced spending means lower revenue for businesses. This could lead to lower wages for employees and fewer orders for suppliers.

High interest rates also hurt stock prices. This is because stocks are valued on the basis of their future earnings. Specifically, what those profits are worth today.

This is calculated using the “risk-free interest rate”. This is usually the interest rate of the benchmark government bond. The higher the rate, the lower the value of future earnings. This puts pressure on stock prices.

So what can you do with your money? Where to invest when interest rates rise?

Here are 5 possibilities…

Fixed deposits

This is the most logical and commonly used choice.

Banks and finance companies offer higher interest rates on deposits. This is a good opportunity for those looking for the security of fixed income securities.

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

If you plan to commit higher amounts in fixed deposits, you should keep in mind that interest rates are likely to increase even more.

So remember to space out your term deposits to take advantage of higher interest rates.

Sovereign bonds

The Indian government now allows retail investors to invest in sovereign bonds.

In November 2021, the RBI launched the Retail Direct Scheme. Under this program, you can open a ‘Retail Direct Gilt Account’ online and immediately start investing in GoI bonds.

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

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

There is no charge to open and maintain the RDG account with RBI. All you have to pay is a nominal payment gateway fee when trading in G-secs.

Corporate debentures

Just like government and financial institutions, businesses also need credit.

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

Thus, they will also seek to raise funds from retail investors. They can do this by issuing debentures. These are fixed income securities backed by fixed assets of a business, such as plant and machinery.

Corporate debentures may offer higher interest rates than bank FDs and government bonds, but they offer the security of neither.

They come with credit ratings issued by rating agencies. However, it is up to the investor to decide if they want to believe these ratings. Indeed, rating agencies do not have a great reputation when it comes to warning investors of a possible default.

Stocks of companies with pricing power (and low leverage)

Why are we talking about stocks in this editorial?

Well, there is a category of companies in the market which are different from others. It’s not that their stock prices are immune to rising interest rates. But they are resilient.

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

In other words, their customers pay for the higher input prices. This guarantees stable margins for these companies. And those steady earnings and dividend payouts.

What does this have to do with higher interest rates?

Well, central banks raise rates to control inflation. Thus, companies that cannot raise prices suffer from lower margins. They also suffer from high interest rates if they have debt on their books. Thus, these actions are hammered.

On the other hand, if a company can handle inflation on its own and doesn’t have a lot of debt (or isn’t in debt), its stock is largely immune to a crash.

If purchased at a reasonable valuation, these stocks could be your multibagger stocks for the next 10 years.

Gold

This may seem like an odd choice.

The the price of gold falls and with good reason. Higher interest rates offer a good alternative for investors looking for security as well as some return on investment.

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

But now is the perfect time to invest in gold.

After all, what better opportunity do long-term investors have to buy gold at a bargain price?

The recent correction in gold provides such an opportunity. Smart investors would do well to buy gold cautiously.

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

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

This article is syndicated from equitymaster.com