The RBI seems to have surprised everyone who gave up on a rate cut by reducing the repo rate by 0.5%. This post is a note to self that, it is immature to get excited because of the cut, and it is best to ignore associated noise and focus on systematic investing.
A rate ‘cut’, allows industries to borrow at a lower interest rate for business expansion. It is generally seen as a sign that the situation is conducive for overall economic growth and increase in corporate earnings. It is a sign that the economy is ready to expand at a faster pace. A more detailed explanation wrt bonds can be found here: The Rate Cut in Perspective.
The converse happens when interest rates are hiked to match growing inflation (typically) which in turn will lead to a slowdown in corporate growth.
Interest rate movements are broadly cyclical with no defined period. All we do know is that the rates cut today are bound to increase at some point in future. This is the fourth time in the last ten years that we have a repo rate of 6.75%. So there is little point in getting overexcited about it. The rate cycle remind me of this labyrinth – The Penrose stairs (impossible stairs) featured in Inception.
Note to self
I invest in equity only for long-term goals. My belief in the asset class is based on a simple belief: a human society has needs and wants. These need and wants are typically going to grow in number, quality and nature. It is the job of various businesses to cater to these needs and wants. For businesses to remain in operation, they must generate profits. These profits are passed over to the shareholders.
Although there would be significant volatility in the short-term (due to sentiment and speculation), I (like any other long-term investor) hold the belief and the hope that while the needs and wants of a society increases, the value of the goods created to cater to them should also increase over time.
This means that the gross domestic product (GDP) which measures this value should also increase over time. Therefore, regardless of interest rate hikes or cuts, the expectation is that the stock index would have risen over a period of time, at approximately the same rate as the GDP.
I can afford to hold this expectation because my goals are several years away (10Y+). So the best action plan for me is to invest systematically each month (aka MDBSC) and participate in the growth of our economy without worrying about short-term movements in the stock market or bond market.
Since there is no guarantee that this expectation will bear fruit, a simple annual review or a personal financial audit will help me evaluate if I am on course for my goals. You can check out the 2013 audit: The year-end personal financial audit and The 2014 personal financial audit and also How to Conduct a Personal Financial Audit.
Speaking of audits, I am thinking about conducting a personal financial audit month in Dec. 2015 to urge readers to audit their own fiscal situation and urge others to do it. What do you think?
Why ignore rate movements and stock market valuations? Why not track them, perhaps I might create more wealth? Why not make some tactical calls?
Thanks, but no thanks. I am happy with the returns that I have made so far and am on course wrt my long-term goals: Retirement Planning: My Story So Far
So systematic investing is more than good enough for me. Setting investment on auto-pilot allows me to focus on the things that I love.
As for tactical calls, yes, I think one should make them but with the right benchmarks – personal ones like the health of our portfolio and not external changes. This is explained in further detail here: How to review your mutual fund portfolio?
The government holds a good chunk of long-term gilts* in my NPS account for me (have no say in the matter!). So I will benefit from this rate cut. Read more here: My National Pension Scheme Performance – Aug 2015. Also the balanced fund I use for my son’s education also hold long term gilts and would gain from this rate cut. They would also lose when there is a rate hike. Gains and losses are part and parcel of the market. I am not going to help my portfolio by reading every bit of speculation about the rate cut.
(*) not recommending long-term gilt funds. Just saying rate cut induced volatility is par for the course. Read why I believe investors who have a choice should not invest in long-term gilt funds: Investing in debt mutual funds: slow and steady wins the race!
End note 1: A rate cut implies home loans rates will get cut. Please make a holistic decision before deciding to service a new home loan. Since all rates are marked to market, there could be a steep increase in rates if inflation increases again. So it may be prudent to get a home loan for as small an amount as possible.
End note 2: A rate cut is not good news for retirees as fixed deposit rates will come down. Debt mutual fund returns will also come down gradually. Not much can be done about this. In the desire to seek higher returns, one should not put the portfolio to higher risk. I state this as many senior citizens have asked me this question.