Tag Archives: asset allocation

Optimizing returns in lower interest regime due to Demonetization

Proof-of-the-pudding of the statement ‘…the things are not completely rosy as the rate of return on some asset classes is expected to come down as well…‘ mentioned in the previous blog of this series – Impact of Demonetization on Individual’s Financial Goals is that the interest rates on bank deposits are already seeing a downtrend (refer News here)

This reduction in interest rate is going to impact the other market instruments like debt market funds (that shall see a sharp rise in their prices), fixed return instruments (rates shall come down significantly), small saving schemes like PPF/EPF (interest rates shall be lowered as these are market-linked).

The above shall in-turn impact the accumulation of funds for individual financial goals. Before looking at measures to be taken to counter this, let’s look at the impact on accumulation of fund with decreasing rate of return

interest-rate-table

returns-table

Below are some of the measures that one can employ in low interest regime staring in the face of investors.

  • Individuals with investable surplus could park the funds in either company fixed deposits (all of which have or are in the process of lowering their interest rates) or invest in long term debt mutual funds (that are expected to see a drop in yield thereby giving a good capital appreciation)
  • Individuals without investable surplus but with regular monthly flow could opt for Recurring Deposits (refer Protecting future investments against falling interest rates blog for details on how RD can be used as an instrument to lock-in currently available higher rate of return for amount to be invested in future)
  • For individuals with higher risk appetite, equity based mutual fund is expected to become darling of the market – given that there are expected to be very few avenues left for investing in future (for details, refer to next blog in this series – ‘Why Equity market should emerge as top investment destination post Demonetization?’
  • Revisit asset allocation and move to tax efficient avenues to enhance the net returns

As Henry Ford said – ‘If you always do what you’ve always done, you’ll always get what you’ve always got.‘ – it’s thus time to invest differently to tide over the changes in post-demonetization era.

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Impact of Demonetization on Individual’s Financial Goals

 

As recommended in my first blog ‘Impact on individuals with this MODIfied India’ in this series ‘Impact of Demonetization on Personal Finance’; the stock market did witness a panic selling on 9th Nov. All those, who had heeded to the advice on buying in that fall, would be sitting on around 20%-30% profit by the end of the day, if invested in fundamentally strong stocks.

Since the Demonetization, a lot has been said and written about the impact of Demonetization on Economy. In today’s blog let’s try to understand the impact of this decision on Financial Goals of an individual.

One of the biggest impacts, that Demonetization is going to have, is that it shall weed out considerable amount of Black Money from the system. One of the bye-products of Black Money is high Inflation. With this cleaning up of the system, inflation is expected to drop considerably. In fact, we might even witness deflation for some time due to this, however, in medium to long term, the inflation shall be tamed.

One of the important factors impacting the financial goal is the rate of inflation. For a goal that is farther away, minor change in the inflation could lead to major fluctuation in the goal amount. Let us take the example of our old friend, Amit, who is now married and have a kid. Amit’s dream has been, to send his kid to a reputed college for a professional course. The current cost of the course is ₹25 Lacs, and the kid is expected to go for this course after 21 years. Assuming an inflation of 8% the cost of this course is going to be close to ₹1.26 Cr after 21 years. The following table depicts the difference in the end amount with various inflation rates.

Current cost of course ₹    25,00,000
Number of years to achieve the goal 21
Rate of Inflation 8% 7% 6% 5% 4% 3%
Cost after 21 years ₹ 1,25,84,584 ₹ 1,03,51,406 ₹ 84,98,909 ₹ 69,64,906 ₹ 56,96,920 ₹ 46,50,736
Difference when compared to 8% base ₹    22,33,178 ₹ 40,85,675 ₹ 56,19,678 ₹ 68,87,664 ₹ 79,33,848
Percentage saving compared to 8% base 17.75% 32.47% 44.66% 54.73% 63.04%

From the above table it is evident that the savings could be as high as 63% if the inflation drops by 5%. Even a 1% drop results in a saving of close to 18% in the amount needed at the time of admission. Amit shall thus be able to attain the goal by investing much lesser amount than he envisioned at the beginning.

However, the things are not completely rosy as the rate of return on some asset classes is expected to come down as well. To understand this, stay tuned for the next blog in the series – ‘Optimizing returns in lower interest regime due to demonetization’

Should you have any query related to any of your goals or above views, feel free to leave a comment.