How to invest in mutual funds during rising interest rates?

Rising interest rates impact both equity and debt mutual fund schemes. Does this mean that you must cancel your SIP investments when the interest rates are rising? The answer is no. Read on to know how rising interest rates impact mutual funds, and how you must invest in mutual funds in such a scenario.

How do interest rates impact mutual fund investments?

A rise in interest rates directly impacts equity and debt mutual fund returns:

• The impact of high interest rates on equity fund: When interest rates rise, banks increase their lending rates, which leads to loans becoming more expensive. This also increases the capital cost of businesses and directly impacts their bottom lines. This, in turn, lowers the yield of equity mutual funds.
• The impact of high interest rates on debt funds: Interest rates are inversely related to bond prices. Therefore, when the interest rates rise, bond prices go down, and vice versa. Hence, when interest rates rise, the prices of existing bonds fall, thereby reducing their demand. As price fluctuation is lower in a short-term debt paper, the impact of high interest rates on medium-to-long-duration papers is more. Hence, debt mutual funds that invest in short-term papers are likely to perform better during high interest rates when compared to medium-to-long-duration papers.

How to invest in mutual funds during rising interest rates?

You can follow a simple three-step process while investing in mutual funds when interest rates are rising:

• Do not interrupt your SIP investments: To make the most of your SIP (systematic investment plan) investments, you must decide on a financial goal and use an SIP calculator to calculate your returns before investing. Interrupting your SIP investments is not recommended, since it directly impacts your ability to achieve your long-term financial goals. You can diversify if you feel the need to do so but be sure to not cancel your SIP investments.  

• If you wish to invest in a new fund, choose a short-term debt fund: You can learn how to invest during rising interest rates by investing some amount in a short-term debt mutual fund. You can also invest in liquid mutual funds for a short duration to put your investment skills to the test during rising interest rates.

• Avoid taking any loans during this period: You must avoid taking on any more debt when interest rates are high. If possible, you should try and postpone the idea of taking a loan in such times. This is because the cost of debt increases when interest rates are high.

Where should you invest when interest rates are high?

As mentioned earlier in the article, rising interest rates impact both equity and debt mutual fund schemes. If you are already invested in an equity fund through an SIP, you must remain invested in it. If you wish to start a new investment, it is advisable for you to invest in a short-term debt fund.

Conclusion

You must avoid cancelling your current SIP investments and invest in a short-term debt fund when interest rates are high. Be sure to use an online SIP calculator to calculate your mutual fund returns before investing.

(Devdiscourse's journalists were not involved in the production of this article. The facts and opinions appearing in the article do not reflect the views of Devdiscourse and Devdiscourse does not claim any responsibility for the same.)