Make the most of rising interest rates

Interest rates

High interest rates are back in the headlines. Escalating prices, higher cost of goods, double digit inflation are words that we are grappling with on a daily basis. In its vigil to combat inflation, the Reserve Bank of India has raised operational policy rates (repo rate and reverse repo rate) by 475 bps (100 bps = 1 percent) since March 2010.

The intent behind raising these key policy rates is to cut money supply in the banking system and therefore the economy so as to bring down inflation. Even as the RBI strives hard to contain inflationary pressures, the surfeit of liquidity and the surprisingly quick recovery in global commodity prices have acted as critical forces in driving up headline inflation in India and abroad.

While as consumers, we may be feeling the pain of rising prices, high interest rates augur well for an individual from the investment perspective. Here is how to can take advantage of high interest rates.

The most common route that one would take in case of high interest rates is to park the surplus funds in a fixed deposit. With deposit rates already in double digits, we would logically be tempted to tap this opportunity. Most of us, however, do not take into consideration the post-tax returns from a fixed deposit. If your income falls in the highest tax slab, you would have to pay 33 per cent tax on your fixed deposit gains, resulting in post-tax gains failing to match the rate of inflation.

There are other investment avenues you can consider which tend to be more tax efficient compared to fixed deposits. You can pursue a fixed maturity plan (FMP) which offers excellent post tax returns with very low interest rate risk. In a FMP, the underlying investment is not subject to market fluctuations because FMPs purchase securities with a fixed date of maturity. This makes FMPs a low risk option in a volatile interest rate scenario. Other short term funds also deliver superior returns in a high interest rate scenario such as ultra short term funds.

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