Dodge the interest rate trap vis-a-vis debt funds

Just like stock prices, interest rates too will rise and fall; however, no one can say which will happen when. Increasingly we live in a volatile climate --- both locally as well as globally. Geopolitical tensions, commodity prices particularly that of oil, the consequent impact on inflation, trade flows, government policies, the threat of terrorism --- all these factors and more ultimately combine to impact rates and therefore an accurate prediction is almost an impossibility.

However, what we do know is that at least in the near future (short-term), interest rates have climbed. An 8.5% to 9% return on short-term debt is definitely possible. The uncertainty prevailing amongst market players can be clearly gauged from the fact that currently the return on even long-term fixed income paper is not much different. (The 10-year government bond yield is going at 8.20%). Normally, there should be a premium for committing your funds for a longer period of time.

Be that as it may, it is indeed possible for investors to avail of the aforementioned rates for little or no risk at all. However, the choice of fund is important. Remember that this is not true for all income schemes available in the market. The average one-year return on most income schemes is still a paltry 4-5% p.a. This happens on account of the fact that existing income schemes are saddled with already invested paper languishing at lower rates. When the current rates in the economy start to climb, this existing low yield paper has to be sold at a discount thereby lowering the NAV and the return on investment. (Also read - How to build your MF portfolio?)