Fixed Deposit rates are rock bottom. What should you do?

RBI recently decided to cut the Repo Rate by 75 bps from 5.15% to 4.40%. It is aimed at bringing down the cost of borrowing and and revive the economic growth, mainly in response to the financial impact of Covid-19 .

Interest rate on the loans by banks, naturally started lowering due to this. However, banks were also be compelled to pay a lesser interest on FDs. SBI reduced its 1 Year FD to just 5.70% interest. The government has also declared lowering of interest rates on small savings schemes. PPF now is at 7.10% interest for April-June 2020 (reduced by 0.80%).

You as an investor might be worried to see the lowering of interest rate on FDs, at the time when your equity investments have also gone down currently. However, you have to think intelligently in this scenario. One of the basic fundamentals of personal investing is to make a proper Asset Allocation. Asset as an investment can be Equity, Fixed Income or Gold. Your entire investment should not be on any single asset class, but a mix of all. Each asset class is unique in nature. Fixed Income should be primarily for the purpose of capital preservation, Equity for capital growth and Gold for hedging or counter-balancing between rise and fall of equity and Fixed Income. 

In Fixed Income Products, remember the interest part which comes, is actually not a "real" income. It's just the value protection of your money against the inflation. Inflation gradually reduces the value of the capital invested. So the interest earned of Fixed Income product acts as a counter against the inflation to preserve the capital value. 

On the other hand, equity return on a longer term is higher than the inflation rate. Thus equity investment potentially gives you a "real" growth on your capital. Its the "real" income, whereby your capital appreciates, even after considering the inflation. But equity has a risk into it as its return is volatile and not fixed. So in order to get a "real" income from your equity investment, equity demands from you a behavioral trait, which is patience, to tide over the volatility.  

Your time horizon of investment should decide the asset class you must invest in. If you need investment money back within 3 years, you should invest in Fixed Income. If the purpose of investment is for a longer personal requirement, you should invest in equity.

So now coming back to the concern in falling interest on your FDs, the solution is a simple process. The first is to stick to your asset allocation i.e. how much you invest in equities vs debt. This means that you do not shift your debt investments into equity and vice-versa. The second is to take a relook at the debt portion of your portfolio and set your  expectations correctly.

Debt should be used for capital preservation and providing stability to your portfolio. Focus on prioritizing safety over returns. Often it is seen that interest rate and inflation rate are internally linked. So if you are now getting a lower interest rate, be assured that the inflation rate in coming days will also be somewhat equally lower. Thereby, your 'real" capital value preservation in still intact.   

The following action points will help you respond appropriately:

• Stick to your asset allocation as per the time you have in your hand for the actual purpose you invested for.

• Continue with PPF and other government schemes if you want assured return

• Spread out FDs across 2 or 3 larger banks. Don't choose any FD simply because it has higher interest rate.

• Choose debt funds that maintain high quality portfolio

Debt funds with Mutual Funds has product which can intrinsically categorized as  "Better than Savings Account", "Better than Fixed Deposit" and "High Quality Debt Funds".

So, hold your nerves, stay calm and continue maintaining your Asset Allocation.