Should investors hold or invest?

Suresh Krishnamurthy

WHEN interest rates are threatening to inch upwards, investors are most likely to be tempted to invest for the short-term and postpone long-term investments, anticipating the rates to gradually move up.

However, even if interest rates do move up in course of time, it is not certain if investors who refrained from investing for the long-term would have benefited. This is because the quantum of interest rate upmove should be such that it compensates the investor for refraining from investing at a higher coupon rate for the long-term.

For example, consider the term-deposit rate structure of the State Bank of India. It offers 5 per cent for a three-month deposit, 6.5 per cent for nine-month and one-year deposits. If an investor invests Rs. 1,000 for a year, he would get Rs. 65 at the end of it. However, if he anticipates interest rates to go up, should he invest for three months now and then for nine months? An investor can opt for that course only if the nine-month deposit rate is likely to move to more than 7 per cent.

Only if the coupon rate on the 9 month deposit is more than 7 per cent would an investor gain, as the total sum he would receive at the end of an year would then be more than Rs. 65. If the interest rate is expected to move up to 7 per cent, the investor does not gain or lose -- the sum received at the end of the year would remain Rs. 65 in both the cases. Any rate below 7 per cent, the investor would lose. Decisions involving a term longer than one year is still more complicated because the calculations need to involve the time value of money.

In this backdrop, retail investors can refrain from taking such risks and without attempting to time the markets, invest regularly. In doing so, the risks of interest rate movements may even-out over time. Also, investors who would like to take advantage of such interest rate movements should take the mutual fund route rather than attempt to take an investment decision on their own.