Outlook English - Print Subscribers Copy Outlook English, 26 February 2018 | Page 62

Debunking Risk Series Reinvestment Risk: How To Buckle It When interest rates on fixed deposits slide, consider other options like equity and gold to fetch long-term regular income I n 2002, Mr Iyer decided to take voluntary retirement. Still in his early 50s, and a banker with a public sector bank, he first calculated how much he needed for his monthly expenses. He also budgeted other expenses like healthcare and costs of his daughter’s higher education. Being an experienced banker, he was meticulous with numbers. He decided to invest in a fixed deposit and in bonds. Iyer’s fixed deposit was for five years while the bonds were of 10 years. With more than two-and-a- half decades of banking experience, his planning was thorough. After all, he had been familiar with both interest rate movements and corresponding inflation. About five years into his retirement, he, however, started feeling the pinch. When his fixed deposit matured, he renewed it for another five years. But as interest rates dropped, he started earning less. Meanwhile, cost of living kept going up. He managed to somehow stick to this plan for another three years, but his capital soon started eroding. As a banker, he knew that was not a good sign. While his bonds were earning a higher rate of interest, the returns on newer bonds in the market were much lower. This meant that when his bonds mature, new investments would offer lower interest. Mr Iyer knew that it was time to explore other opportunities as his income from interest will not be sufficient to meet his needs. By now, he was already in 62 OutlOOk 26 February 2018 his early sixties, and had no medical liabilities. While he understood risk as a banker, he ignored to look into reinvestment risk. This is a typical problem with many of us. To meet any kind of long-term regular income requirement, investing in fixed interest investments have inherited risk. When fixed deposits and bonds mature, there is a possibility that interest rates have gone down and, renewed interest earning could be lower compared to earlier earning. Always factor in reinvestment risk while investing in fixed deposit, bonds, etc. Risk here means that eventuality may or may not happen. This, however, does not mean that when a fixed deposit or bond matures, interest earned on renewed fixed deposit or bond will be lesser than the older one. But there is a possibility that it may happen. How to deal with risk? For long-term regular income, avoid investing only in fixed deposits or bonds. Instead, invest a small portion in equity or gold. One can invest directly or through a mutual fund. That small portion will be able to generate higher returns and ensure appreciation in capital. Another strategy to ensure while investing in fixed deposit and bonds is to have different maturity periods. That is, if you have `10 lakh to invest, instead of investing all of them in a five-year fixed deposit, invest in a plan with a staggered maturity period of three, five and seven years, based on your fund requirement. While investing in fixed deposits or bonds for regular income, please be careful with reinvestment risk. Gaurav Mashruwala (Financial Planner & Author of Yogic Wealth) [email protected]