How fixed-income assets are impacted by inflation and what you can do about it

 How fixed-income assets are impacted by inflation and what you can do about it

How fixed-income assets are impacted by inflation and what you can do about it

Investors encounter difficulties when inflation persistently surpasses fixed income rates. Changing up your rates and maturities may help lower your risk of inflation.

Because inflation impacts interest rates, especially the repo rate, it has a substantial impact on returns on fixed-term assets.

The intricate nature of the present inflation climate has significant effects on investment strategies and economic dynamics. Bonds and debt instruments are particularly appealing when it comes to fixed income possibilities. These financial products are a desirable choice for anyone looking for steady and predictable profits since they pay investors interest on a regular basis.

The impacts of inflation on fixed-term assets are complex and mostly show themselves as a decline in buying power. Real value declines when the general price level rises because the fixed returns on these assets have less buying power.

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) decided to stick with the status quo at its most recent policy meeting in December, meaning that the repo rate would remain at 6.50 percent. The MPC members unanimously agreed that the outcome was in accordance with market expectations. Interestingly, the repo rate has not moved for the sixth straight policy meeting.

Effect on the returns on investments

Because inflation impacts interest rates, especially the repo rate, it has a substantial impact on returns on fixed-term assets.

This is influenced by the repo rate, or the interest rate at which central banks lend to commercial banks. Fixed deposit (FD) interest rates rise in tandem with an increase in the repo rate, and they decline in tandem with a reduction in the repo rate. Furthermore, if central banks raise interest rates in an effort to fight inflation, the value of low-yield bonds may decline, which might result in losses for investors who have to sell their bonds before they should.

Frequently, investors use tactics like inflation-protected securities and diversification to shield their fixed-term assets from the effects. However, investors have difficulties—particularly given the rising costs of food and fuel—when inflation persistently surpasses fixed income rates, leading to negative real returns.

Lower repo rates lower banks' cost of capital, which makes them less dependent on fixed deposits to satisfy their capital requirements and, as a result, lowers FD interest rates. On the other hand, banks raise loan interest rates in response to a rise in the repo rate, and they then raise FD interest rates to draw in depositors.

Therefore, in the present environment, the optimal fixed repo rate for FD interest rates is around 6.50 percent.

Reducing the risk of inflation while investing in fixed income

Bonds with various maturities and yields may be added to a fixed income portfolio to diversify it and lower the risk of inflation. Higher yields are often seen in longer-term bonds, which may help them stay up with inflation and maintain buying power.

Bonds with floating rates, whose interest rates are frequently adjusted to match reference rates, provide some protection against inflation and growing interest rates. They provide investors the chance to benefit from growing interest rates.

In the Indian setting, investments in physical assets like real estate or commodities might serve as a hedge against inflation. During inflationary times, these assets increase in value and may even offset losses on fixed income investments.

A major obstacle for investors looking for security and steady returns on their fixed income investments is India's present inflation situation. Investors should place a high priority on diversity in order to shield their portfolio from the negative consequences of market volatility.

Inflation is an unavoidable event in every rising country, pushing long-term rates down and perhaps decreasing the value of fixed income assets over time. As a result, before making an investment, investors should carefully consider their long-term financial goals, obligations, and risk tolerance. The future of fixed income investments in the nation will be significantly shaped by the RBI's attempts to regulate and control inflation.