Interest rates have an important role to play in most financial products. Right from loans to investments, the interest rate can determine your returns, profit margins, and ultimately investment decisions to a great extent. Interest rates can also impact mutual funds.
Read on to know what interest rates in mutual funds are and how they can affect you.
What are interest rates?
The interest rate is set by the Reserve Bank of India (RBI) and is also known as the repo rate. It is a tool that the RBI uses to control inflation in the economy. The repo rate influences lending and borrowing patterns in the country, which in turn impacts the prices. When the repo rate is low, loans become more affordable, and people borrow more money. This increases the cash flow and ultimately increases the prices. On the other hand, when the repo rate is high, people borrow less money and purchase fewer commodities. This reduces the cash flow in the economy and reduces prices.
How does the interest rate affect mutual funds online?
Interest rates can affect debt and equity mutual funds in different ways. Here’s how:
- Impact of interest rates on debt mutual funds: Debt funds invest in fixed income securities like bonds. A bond is a type of debt instrument where the investor is the lender. Bonds are issued by the government or corporate or municipal bodies to generate more funds. When the repo rate is low, the debt fund’s NAV (Net Asset Value) increases, making it more attractive to investors. When the repo rate is altered, the bond’s value also changes.
Here’s how this works: Suppose you invest in a bond that offers a coupon/ return rate of 5%. If the price of the bond is Rs. 100, your return would be Rs.5. If the RBI increases the repo rate to 10%, the new bond will return Rs. 10. As a result, investors will rush to buy the new bond that offers a yield of Rs. 10. So, to encourage investors to invest in the old bond, its value may be decreased to Rs. 80 instead of Rs.100.
- Impact of interest rates on equity mutual funds: In equity funds, a decrease in the repo rate can lead to more gains. If the rate of interest decreases, corporates have more money to fund their growth and expansion. This can increase stock prices. On the other hand, if the interest rate increases, investors may shift their money to low risk, fixed income investments.
To sum it up
It is important to understand how interest rates change the value and yield of an investment to make better investment decisions. It may also be advised to keep a diversified portfolio to ensure low volatility. You can use the Tata Capital Moneyfy app to help you manage your SIPs better and let you track your money anytime and anywhere.