Category: personal finance

Rethinking the Rule of 100: A Modern Approach to Investment Risk

Rethinking the Rule of 100

A Story to Begin With

Two investors walk into the same financial planning office.

The first is 28 years old, earning a decent salary but juggling a home loan, car EMI, and plans for a child’s education. The second is 62, recently retired, debt-free, with accumulated savings and a steady pension.

According to the Rule of 100, the younger investor should aggressively invest in equities, while the older one should sharply reduce stock exposure. But when you look at their real financial lives, the picture feels counterintuitive. The younger investor cannot afford large losses, while the retired investor may actually have the stability to ride out market volatility.

This disconnect raises an important question:
Should age alone determine how much investment risk you take?

That question sits at the heart of this article.

The Rule of 100 – Asset Allocation by Age

When it comes to investing, one of the most common questions people ask is:
How much should I invest in equities and how much in safer assets?

To simplify this decision, financial planners have long relied on age-based formulas—the most popular being the Rule of 100.

At first glance, the rule seems logical and easy to follow. But does it truly reflect how real people earn, save, and spend today? Let’s take a closer look.

What Is the Rule of 100?

The Rule of 100 is a basic guideline used to determine asset allocation based on age.

Formula:
100 − Your Age = Percentage of your portfolio invested in equities

The remaining portion is allocated to bonds, debt instruments, or other relatively low-risk assets.

Simple Examples

  • Age 30
    • 70% in stocks
    • 30% in bonds/debt
  • Age 50
    • 50% in stocks
    • 50% in bonds/debt

The Logic Behind the Rule

The rule is built on a straightforward assumption:
risk tolerance declines with age.

Younger investors are expected to have:

  • Longer investment horizons
  • More time to recover from market downturns

Older investors, on the other hand, are assumed to:

  • Prefer stability over growth
  • Focus on capital preservation and steady income

This thinking made sense decades ago—but markets, careers, and lifespans have changed.

Why the Rule Evolved: Rule of 110 and Rule of 120

As life expectancy increased and inflation became a bigger threat, financial advisors began adjusting the formula.

Rule of 110

110 − Age = Equity allocation

  • Age 30 → 80% equities
  • Age 50 → 60% equities

This version recognizes that:

  • People are working longer
  • Retirement needs are larger
  • Equity growth is crucial to beat inflation

Rule of 120

120 − Age = Equity allocation

  • Age 30 → 90% equities
  • Age 50 → 70% equities

This rule is typically suggested for investors with higher risk tolerance or those relying heavily on equity markets for long-term wealth creation.

A comparison of Rule of 100 vs Rule of 110 vs Rule of 120 is shown in the chart below:

What the Chart Shows

  • X-axis: Investor age
  • Y-axis: Suggested equity allocation (%)

Three declining lines represent:

  • Rule of 100 (most conservative)
  • Rule of 110 (moderate)
  • Rule of 120 (most aggressive)

Key Takeaways:

  • All three rules reduce equity exposure linearly with age
  • The difference between rules becomes more pronounced at younger ages
  • Even at age 60–70, Rule of 120 still suggests meaningful equity exposure, reinforcing the inflation-risk argument

The Big Problem With All These Rules

Despite their popularity, the Rule of 100, 110, and 120 share one major flaw:

They assume age alone determines risk capacity.

In reality, age tells only part of the story.

A Contrarian Perspective: When the Rule Breaks Down

Younger Investors Aren’t Always Risk-Takers

Many young investors face:

  • Lower incomes and limited savings
  • Home loans, car EMIs, and education expenses
  • Small emergency buffers

For them, a sharp market fall can cause real financial stress. Even though time is on their side, their ability to absorb losses may be limited. In such cases, aggressive equity exposure can do more harm than good.

Older Investors May Have Higher Risk Capacity

Ironically, many older or retired investors:

  • Are free from major financial obligations
  • Have accumulated wealth, pensions, or rental income
  • Can emotionally handle short-term volatility

For them, maintaining meaningful equity exposure may actually be necessary to protect purchasing power against inflation.

The Real Question: Risk Tolerance or Risk Capacity?

This is where most age-based rules fall short.

  • Risk tolerance is how comfortable you feel with volatility
  • Risk capacity is whether your finances can survive a downturn

Risk capacity depends far more on:

  • Cash flows
  • Liabilities
  • Financial security
  • Emergency reserves

—not just your age.

Final Thoughts

The Rule of 100 and its modern variations are useful starting points, not formulas to follow blindly.

Smart asset allocation requires balancing:

  • Age
  • Income stability
  • Financial responsibilities
  • Long-term goals
  • The ability—not just the willingness—to take risk

In investing, simplicity helps.
But context matters even more.

What Do You Think?

  • Should age alone determine how much risk an investor takes?
  • Have your financial responsibilities increased or reduced your ability to invest in equities?
  • For younger investors with EMIs, is aggressive equity allocation practical—or risky?
  • Should retired investors reduce equity exposure simply because of age?
  • Which matters more: risk tolerance or risk capacity?
  • Do you follow the Rule of 100 (or 110/120), or have you created your own approach?

👉 Share your views—your experience may help others rethink how they invest.

How to use RSI for Trading Success

Relative Strength Index (RSI)


A momentum indicator developed by J. Welles Wilder Jr. (1978) that measures the speed and magnitude of price changes. Traders use RSI to identify whether a stock is overbought or oversold.

RSI Scale

RSI moves between 0 and 100.

RSI Formula (Simple Version)

  • RS = Average Gains / Average Losses
  • RSI = 100 – [100 / (1 + RS)]

(You don’t usually need to calculate it manually—charting tools do it automatically.)

How to Read RSI

Overbought (RSI > 70)

  • An RSI above 70 suggests that the asset may be overbought, indicating a potential price correction.

Oversold (RSI < 30)

  • An RSI below 30 suggests the asset may be oversold, indicating a possible rebound.

Example Chart Explanation

1. Price Chart

(shows the stock’s price movement over time.)

2. RSI Chart

(shows RSI oscillating between 0 and 100 with reference lines at 30 and 70.)

Overbought Example

When RSI rises above 70:

  • Momentum is strong but may be overstretched.
  • When RSI turns back below 70, the price often slows down or pulls back.

Oversold Example

When RSI falls below 30:

  • Indicates strong downside pressure.
  • When RSI rises above 30, price often stabilizes or rebounds.

How Traders Use RSI

  1. Entry Signal (Buy) : RSI crosses above 30 → possible buying opportunity.
  2. Exit Signal (Sell) : RSI crosses below 70 → possible selling signal.
  3. Trend Reversals (Divergence) Traders watch for differences between price movement and RSI movement:
    • Bullish Divergence:
      Price makes lower lows, but RSI makes higher lows.
      → Suggests a potential upward reversal.
      → Buy when RSI crosses above 30.
    • Bearish Divergence:
      Price makes higher highs, but RSI makes lower highs.
      → Suggests a potential downward reversal.
      → Sell when RSI crosses below 70.

Limitations

  • RSI can stay overbought or oversold for long periods during strong trends.
  • It may give false signals in sideways or choppy markets.
  • Works best when combined with price action, moving averages, MACD, or volume confirmation.

Conclusion

The RSI is a simple yet powerful indicator that helps traders understand momentum and identify potential turning points in the market. While it provides helpful signals for entries, exits, and trend reversals, it should not be used alone. Combining RSI with other technical tools and overall market context leads to more reliable and confident trading decisions.

Understanding Moving Averages in Trading

Moving Average (MA)

A moving average represents the average price of a security over a specific period, helping traders smooth out short-term price fluctuations and identify overall trends.

Types of Moving Averages

TypePeriod CoveredUsageTrend Focus
200-Day Moving Average (200-DMA)Last 200 trading daysLong-term trend identificationBroad market direction
50-Day Moving Average (50-DMA)Last 50 trading daysShort- to intermediate-term analysisRecent price momentum

How to Interpret a Moving Average

Golden Cross (Bullish Signal)

Definition:
Occurs when the 50-DMA crosses above the 200-DMA.

Interpretation:
→ Signals a bullish trend, indicating potential long-term upward momentum.
The crossover shows that short-term momentum is overtaking long-term averages, suggesting renewed market strength.

Confirmation:
Traders look for increasing trading volumes or other indicators (like RSI or MACD) to validate the uptrend.

Death Cross (Bearish Signal)

Definition:
Occurs when the 50-DMA crosses below the 200-DMA.

Interpretation:
→ Signals a bearish trend, indicating potential long-term downward momentum.
This suggests that short-term weakness is overtaking long-term support levels.

Confirmation:
Traders often seek validation through
• A break of key support levels
• Declining trading volumes
• Other bearish indicators

Example: Golden Cross – Northern ARC Capital Ltd

Northern ARC Capital Ltd (Chart source : https://www.screener.in)

In the chart above:

  • The blue line represents the price movement of the stock on NSE.
  • The orange line is the 50-Day Moving Average (50-DMA) — short- to mid-term trend indicator.
  • The grey line is the 200-Day Moving Average (200-DMA) — long-term trend indicator.
  • The light blue bars show the trading volume.

Observations

  1. October 2024 – March 2025:
    The stock remained in a downtrend, with the 50-DMA below the 200-DMA — a bearish phase. Prices continued to decline as momentum weakened.
  2. April – June 2025:
    The price started recovering, forming higher lows. The 50-DMA began to turn upward, indicating strengthening short-term momentum.
  3. June – July 2025: The Golden Cross ✨
    The 50-DMA crossed above the 200-DMA, forming a Golden Cross — a bullish signal suggesting a potential long-term uptrend was beginning.
    This crossover was also supported by a spike in trading volume, adding credibility to the move.
  4. August – October 2025:
    After the crossover, prices continued to trend upward, confirming the bullish reversal.

Summary

  • A Moving Average helps visualize the trend by averaging prices over time.
  • The 50-DMA tracks short- to mid-term momentum, while the 200-DMA tracks long-term direction.
  • Golden Cross → Bullish trend may be forming.
  • Death Cross → Bearish trend may be developing.
  • Always confirm signals using other indicators (RSI, MACD, Volume) before making trading decisions.

Quick Insight: RSI and MACD

Relative Strength Index (RSI):
A momentum indicator that measures the speed and magnitude of price changes.

  • RSI ranges from 0 to 100
  • Above 70 → overbought (potential pullback)
  • Below 30 → oversold (potential rebound)

Moving Average Convergence Divergence (MACD):

A trend-following momentum indicator that shows the relationship between two moving averages of a stock’s price.

  • MACD line crossing above the Signal line → bullish signal
  • MACD line crossing below the Signal line → bearish signal

These indicators help traders confirm whether a Golden Cross or Death Cross is supported by momentum strength or weakness.

Your Turn

Have you ever used moving averages to identify entry or exit points in your trades?
What signals or confirmations do you rely on most — the crossover itself, volume trends, or other indicators?

What is an Arbitrage Fund? Key Benefits and Risks Explained

Arbitrage Fund Overview

An arbitrage fund is a type of hybrid mutual fund that seeks to generate returns by exploiting price discrepancies of the same security in different markets (for example, between the cash/spot market and the futures market). They rely on arbitrage opportunities rather than directional bets on stock prices.

Advantages

  • Tax efficiency: Classified as equity-oriented mutual funds, so they enjoy lower tax rates compared to fixed deposits and most debt funds.
  • Relatively lower risk than equity funds: Returns are not driven by stock price appreciation but by arbitrage opportunities, making them less risky during volatile markets.
  • Good for short-term parking: Useful for investors who want to park money for a few months with lower risk and better post-tax returns than liquid/debt funds.

Disadvantages

  • Not suitable for long-term wealth creation: Returns are moderate (typically 4–7% p.a.), so they do not generate high capital appreciation like pure equity funds.
  • High expense ratio: Arbitrage opportunities require frequent trading, which leads to higher costs compared to debt or liquid funds.
  • Returns depend on volatility: If markets are stable with fewer arbitrage opportunities, returns may be lower.

Taxation (as Equity Fund)

  • Short-Term Capital Gains (STCG)
    • Holding Period: Less than 12 months.
    • Tax Rate: 20%.
    • Surcharge & Cess: Applicable on top of the 20% tax.
  • Long-Term Capital Gains (LTCG)
    • Holding Period: More than 12 months.
    • Tax Rate: 12.5%.
    • Exemption: The first ₹1.25 lakh of LTCG is tax-free annually.

Comparison: Arbitrage Fund vs Equity Fund vs Debt Fund vs FD:

FeatureArbitrage FundEquity FundDebt FundFixed Deposit (FD)
Nature of InvestmentHybrid (equity + derivatives)Pure equity (stocks)Bonds, govt. securities, corporate debtBank deposit
Risk LevelLow–ModerateHighLow–ModerateVery Low
Return Potential4–7% (linked to arbitrage opportunities)High (10–15%+ in long term, but volatile)5–8% (depends on interest rate cycle)5–7% (fixed depending on tenor)
Best Use CaseShort-term parking of fundsLong-term wealth creationMedium-term income & stabilitySafe savings, capital protection
LiquidityHigh (T+1 or T+2 redemption)High (but market risk)HighMedium (premature withdrawal penalty)
Taxation – STCG20% (if held < 12 months)20% (if held < 12 months)taxed at income slabInterest taxed at income slab
Taxation – LTCG12.5% above ₹1.25 lakh (if held > 12 months)12.5% above ₹1.25 lakh (if held > 12 months)20% with indexation (if held > 3 yrs)No LTCG; interest always taxed
Safety of CapitalRelatively safe (but not guaranteed)Market dependentSafer than equity, but credit risk possibleGuaranteed by bank (up to ₹5 lakh insured per depositor)
Expense RatioHigh (due to frequent trades)ModerateLow–ModerateNone
Who Should Invest?Conservative investors seeking better-than-FD short-term returnsAggressive investors with long-term horizonConservative to moderate investors looking for stable returnsRisk-averse investors wanting fixed guaranteed income

Visual Comparisons

Average Returns Comparison (%)

Relative Risk Levels (1=Very Low, 4=High):

Summary:

  • Arbitrage Funds → Good for short-term (low-risk, tax-efficient).
  • Equity Funds → Best for long-term wealth creation.
  • Debt Funds → Balanced choice for medium-term safety + returns.
  • FDs → Safe but least tax-efficient.

In short: Arbitrage funds are low-risk, tax-efficient short-term options but not for long-term growth.

Understanding Credit Score in India: A Complete Guide

In today’s consumer-driven market, the desire to own the latest products often surpasses income levels, making consumer credit an essential tool for fulfilling aspirations. However, securing credit from banks hinges on having a good credit score—a vital indicator of financial health.

In India, four credit bureaus approved by the Reserve Bank of India (RBI)—CIBIL, Experian, CRIF High Mark, and Equifax—assign credit scores to individuals based on their financial behavior and credit history.

What is a Credit Score?

A credit score is a three-digit number, typically ranging from 300 to 900 in India, that reflects an individual’s creditworthiness. It is calculated based on factors such as credit history, repayment behavior, and financial habits.

Score Ranges:

  • 750 and Above: Excellent – Higher chances of loan approval with favorable terms.
  • 650–749: Good – May qualify for credit, but not always at the best interest rates.
  • 550–649: Average – Higher likelihood of rejection or unfavorable loan terms.
  • Below 550: Poor – Indicates significant risk to lenders.

Factors Affecting Credit Scores

  1. Credit Composition
    Maintaining a diverse mix of credit accounts, such as car loans, credit cards, and housing loans, can positively impact your credit score. It demonstrates your ability to manage different types of credit products effectively.
  2. Payment History
    A consistent record of on-time payments is the most critical factor influencing your credit score. Late or missed payments can significantly harm your creditworthiness.
  3. Credit Utilization
    This reflects how much of your available credit limit you are using.
    • High utilization such as using 90% of your credit limit—signals a stretched financial position and negatively impacts your score.
    • Aim to keep your utilization ratio below 30% to maintain a healthy credit profile.
  4. New Credit Accounts
    Opening multiple new credit accounts or having frequent credit inquiries in a short period may signal financial risk and lower your score. Be cautious and strategic when applying for new credit.

Key Insights for Improving or Maintaining a Good Credit Score

i. Monitor Your Credit Report Regularly

  • Errors in your credit report, such as incorrect defaults or unauthorized accounts, can negatively impact your score.
  • Regularly review your report from credit bureaus like CIBIL, Experian, Equifax, or CRIF High Mark.

ii. Pay Your Bills on Time

  • Late payments on loans, credit cards, or utility bills significantly affect your score.
  • Setting up automated payments can ensure consistent on-time payments.

iii. Manage Credit Utilization

  • Keep your credit utilization ratio below 30% of your total credit limit.
  • Regularly pay off credit card balances to reduce utilization and boost your score.

iv. Avoid Excessive Credit Inquiries

  • Each loan or credit card application results in a “hard inquiry,” which can temporarily lower your score.
  • Space out credit applications and avoid applying for multiple accounts at once.

v. Maintain a Long Credit History

  • The length of your credit history impacts your score. Keeping older accounts active can be beneficial.
  • Avoid closing old credit cards unless absolutely necessary.

Factors That Don’t Affect Credit Scores

  • Savings Accounts or Fixed Deposits: These are not part of your credit profile.
  • Income Level: A credit score reflects financial behavior, not income.
  • Soft Inquiries: Checking your own credit score does not negatively impact it.

Insights for Young Professionals and Students

  • Start early by applying for a small credit card or loan to build a credit history.
  • Use secured credit cards (backed by fixed deposits) to establish credit if you’re just starting out.
  • Always pay your dues in full to avoid the temptation of carrying balances forward.

Final Thoughts

Your credit score is a reflection of your financial habits. By understanding the factors that influence your score and following these strategies, you can build a strong credit profile. A good credit score ensures access to financial opportunities and lays the foundation for a secure financial future

Why Hyundai Motor India’s IPO Didn’t Attract Retail Investors?

Hyundai Motor India’s IPO, the largest in India’s history, was subscribed 2.37 times on the final day, mainly driven by qualified institutional buyers (QIBs). Retail and non-institutional investors showed significantly less enthusiasm, subscribing to only 50% and 60% of their allotted shares, respectively. This tepid response from retail investors can be attributed to several key factors:

  1. High Valuation: Although Hyundai’s price band was aligned with competitors like Maruti Suzuki, many retail investors found the pricing expensive, with little room for listing gains. The stock’s price-to-earnings ratio and overall valuation appeared unattractive, especially in the context of broader market uncertainty. This sentiment is reflected in the Hyundai IPO’s grey market premium (GMP), which initially made a high of ₹ 570 but dropped to ₹0 by 17th October. The sharp decline in GMP indicated fading expectations for immediate post-listing profits, further dampening enthusiasm among retail investors, who are often drawn to IPOs with short-term gains potential.
  2. Offer for Sale (OFS): Since the IPO was an offer for sale (OFS), it meant that the existing promoters were selling their stake rather than raising new capital for growth. Investors often prefer fresh issues that inject capital into the company for future expansion, which wasn’t the case here. The lack of fresh funds for growth-oriented initiatives could have contributed to the lukewarm reception.
  3. Market Volatility and Economic Concerns: Given the current economic uncertainties, including inflationary pressures, global slowdown concerns, and geopolitical issues, retail investors may have been hesitant to commit to new investments, especially in large-ticket IPOs.
  4. Automotive Industry Headwinds: While Hyundai maintains a strong market position, particularly in the SUV segment, the broader automotive industry is grappling with several challenges. Slowing sales, rising unsold inventory at dealerships, and increasing competition from electric vehicles (EVs) have created a cautious outlook. Moreover, long-term concerns over the future of internal combustion engine (ICE) vehicles amid growing regulatory and environmental pressures have added uncertainty to the industry’s trajectory. An example of this cautious sentiment comes from Bajaj Auto’s post-results earnings call, which highlighted the muted start to the festive season, traditionally a key period for auto sales in India. Bajaj Auto reported that sales growth during the festive season fell below expectations, with a projected increase of only 3-5%. Additionally, for the full fiscal year FY25, Bajaj Auto estimated domestic two-wheeler industry growth at a modest 5%, reflecting the headwinds the industry is facing. These broader sectoral struggles likely contributed to the cautious sentiment among retail investors in Hyundai’s IPO, as they weighed the risks of investing in a sector undergoing significant transformation.

In contrast, Qualified Institutional Buyers (QIBs) showed strong interest, subscribing heavily to the IPO. This reflects institutional confidence in Hyundai’s long-term potential, but retail investors appeared more focused on short-term risks and valuation concerns.

Understanding Asset Allocation for Investors

One of the key component of investment strategy for investors is allocation of their capital over various asset classes. Understanding of asset classes is important for allocation of capital as each asset class comes with it’s unique characteristics, risks, and potential returns.

Overview of Asset Classes:

  1. Equities (Stocks):
    • Represent ownership in a company.
    • Typically offer higher risk and reward (returns).
  2. Fixed Income Securities (Bonds):
    • Debt instruments where investors lend money to corporations or governments in exchange for periodic interest payments.
    • Generally offer lower risk and lower returns than equities .
    • Provide regular income, making them suitable for more conservative investors or those seeking stable income.
  3. Commodities:
    • Physical assets such as gold, oil, agricultural products, and metals.
    • Tend to act as a hedge against inflation and provide portfolio diversification.
    • Prices can be volatile due to supply and demand dynamics, geopolitical events, and economic factors.
  4. Cash and Cash Equivalents:
    • Include savings accounts, Treasury bills, money market funds, and short-term government bonds.
    • Highly liquid and low-risk, but offer lower returns, often below inflation rates.
    • Serve as a safe haven for capital preservation and short-term liquidity needs.
  5. Real Estate:
    • Investment in property such as land, residential, or commercial buildings.
    • Provides potential for steady income through rent and long-term appreciation in property value.
    • Can act as a hedge against inflation but may involve high initial costs, illiquidity, and location-specific risks.

Key takeaways on asset allocation:

  1. Equities:
    • High risk, high reward, and growth-oriented. Suitable for long-term capital appreciation but subject to market volatility.
  2. Fixed Income Securities (Bonds):
    • Lower risk, lower returns, and a source of regular income. Bonds act as a stabilizing force, especially in volatile markets. Sensitive to interest rate fluctuations.
  3. Commodities:
    • Provide diversification and inflation protection. Their prices are influenced by forces of global supply, demand, and geopolitical factors, offering opportunities in times of economic uncertainty. They often perform well when other asset classes (like equities) are underperforming, especially during inflationary periods. For example, gold typically rises during economic uncertainty or currency devaluation.
  4. Cash and Cash Equivalents:
    • Highly liquid and low-risk, but with minimal returns. Best used for short-term needs and as a liquidity cushion. Overexposure can lead to erosion of purchasing power over time because of inflation.
  5. Real Estate:
    • Offers income through rent and the potential for appreciation. However, it carries risks like illiquidity and regional market volatility. REITs offer a more liquid way to gain exposure to real estate markets.

Asset Allocation Strategies:

  • Conservative Investors: Focus on stability and capital preservation. They prioritize bonds, cash, and conservative assets like real estate and gold.
  • Aggressive Investors: Aim for long-term growth, accepting short-term volatility. They tend to favor equities, commodities, and higher-risk real estate investments.
  • Moderate Investors: Strive for a balanced portfolio, mixing equities and bonds, with smaller allocations to real estate and commodities to manage risk and achieve steady growth.

Dynamic Asset Allocation:

Asset allocation is not static. It evolves based on changes in an investor’s life stage, goals, or market conditions. Younger investors, with a longer investment horizon, tend to favor equities, while those nearing retirement may shift towards fixed-income assets to ensure stability and income generation. Rebalancing portfolios over time ensures the asset mix aligns with changing risk tolerance and financial goals.

Final Thoughts:

An optimal asset allocation strategy allows investors to balance risk and reward effectively, while adjusting to market shifts and personal financial goals. Periodic review and rebalancing ensures that portfolios continue to meet the needs of investors at different stages of their financial journey.

Equity vs Precious Metals: Investment Insights in 2024

Post-COVID, investors have seen significant wealth creation, with strong returns across various asset classes. The last 12 months have been especially rewarding, with major indices and commodities posting impressive gains:

Asset classReturns
Equity: S&P 50025.31% (as of August 31, 2024)
Equity: NIFTY31.08% (as of August 31, 2024)
Gold39.77% (source: Goldprice.org)
Silver40.71% (source: Goldprice.org)

Key Insights:

Precious metals, particularly Gold and Silver, have outpaced equity markets. This reflects investor behavior that hedges against inflation and uncertainty, especially as interest rates stayed high for much of this period.

With the Federal Reserve’s 50 basis point rate cut on September 18, 2024, and the expected additional 25 basis point cuts in November and December, the investment environment is shifting. Adding to this, the People’s Bank of China has implemented measures such as reducing the reserve ratio and lowering repo and lending rates to boost their slowing economy. The following analysis outlines the potential impact of this low-interest-rate environment on key asset classes.

Impact of Low interest rate on various Asset classes:

Equity:

Equity markets tend to perform well in a lower interest rate environment due to:

  1. Reduced borrowing costs: Companies with low cost of borrowing can finance operations more cheaply, potentially boosting their earnings and driving stock prices higher.
  2. Increased liquidity: A loose monetary policy pumps liquidity into the market, often fueling growth in stock markets.

However, a word of caution:

NIFTY’s P/E Ratio of 24.1 appears somewhat elevated. Historically, a P/E ratio below 20 is considered reasonable. For NIFTY to maintain its upward trajectory, corporate earnings need to keep pace with the market valuations. If corporate earnings do not grow in line with market valuations, stock prices may face downward pressure or correction.

Gold:

Gold has traditionally been a go-to asset in times of economic uncertainty and rising inflation. In a falling interest rate environment:

  1. Opportunity cost of holding gold diminishes: With low returns from bonds and fixed-income assets, investors often turn to gold as a safe haven.
  2. Currency depreciation: A lower interest rate environment is likely to weakens the U.S. dollar and other global currencies, which typically boosts demand for gold, as gold is priced in dollars.
  3. Risk of inflation resurgence: With central banks adopting loose monetary policies (low interest rates, increased money supply), inflation may return, further pushing gold prices higher.

Central Bank Gold Demand: Central banks have increased their gold reserves dramatically, with 2022 seeing a 140% rise in purchases to 1,082 tonnes (up from 450 tonnes in 2021). In 2023, demand remained robust at 1,037 tonnes (Metals Focus, World Gold Council). This strong institutional demand provides a significant price floor and future support for gold prices.

Silver:

Silver, like gold, benefits from lower interest rates and serves as an inflation hedge. However, its dual nature as both a precious and industrial metal provides additional tailwinds:

  1. Industrial demand: Silver is widely used in electronics, solar panels, and manufacturing, so its price is closely linked to global economic recovery. As economies rebound, demand for industrial metals like silver tends to rise.
  2. Inflation hedge: Like gold, silver acts as a store of value, making it attractive to investors concerned about inflation, especially when interest rates fall.

Summary:

  • Equity (NIFTY): Expected to benefit from cheaper borrowing costs and increased liquidity, but high valuations (P/E 24.1) mean earnings growth is essential to sustain current levels. Without that, equities face a correction risk.
  • Gold: Poised to continue its strong performance as inflation risks remain, weakened currencies, and continued central bank demand.
  • Silver: Likely to outperform due to its dual role as a precious and industrial metal. Its industrial demand will rise in line with economic recovery, while its inflation-hedging properties will maintain investor interest.

Conclusion:

Future performance across these asset classes will largely depend on global monetary policies, inflation trends, interest rate adjustments, and economic growth. Investors should remain cautious, especially in equities where high valuations could lead to corrections. Monitoring central bank actions, inflationary pressures, and shifts in economic policies will be essential to navigating this evolving market environment. Balancing risk and reward will require staying informed and vigilant.

Understanding ROCE: A Key Metric for Business Efficiency

What is Return on Capital Emplyed (ROCE)?

ROCE is a crucial metric to assess how efficiently a company is utilizing its capital employed to generate profits. It provides insight into how well the company is using both equity and debt to generate returns for it’s stakeholders.

Here’s a quick breakdown of the formula and its components:

  • ROCE = EBIT / Capital Employed

Where:

  • EBIT (Earnings Before Interest and Taxes): This measures the operating profitability of a company before considering interest and taxes.
  • Capital Employed: This represents the total funds employed in the business, calculated as Total Assets – Current Liabilities. Alternatively, it can be understood as the sum of Equity capital + Non-current liabilities (long-term debt).

Why is ROCE important?

  1. Measures Efficiency: ROCE indicates how much return is generated for each dollar of capital employed, making it a critical efficiency metric.
  2. Importance in Capital-Intensive Industries: It’s especially useful for comparing companies in industries that require significant investments in assets, such as manufacturing or utilities.
  3. Comparison Across Firms: A higher ROCE signifies more efficient use of capital and can be a key differentiator when evaluating companies with similar operations.

ROCE – Limitations

  • Unutilized Cash: If a company has large reserves of unutilized cash, it might distort the ROCE figure, making it less meaningful.
  • Fluctuations in Capital: Since capital employed can change over time, the timing of the calculation can affect the accuracy of the ROCE.
  • Some analysts may choose to calculate ROCE based on the average capital employed based on the average of opening and closing capital employed.

Example: Hindustan Unilever Ltd (HUL) ROCE Calculation

₹ in Crores Mar-24 Mar-23 Mar-22 Mar-21
EBIT 14,264 13,460 11,980 10,723
Total Assets (A) 78,499 73,087 70,517 68,757
Current Liabilities (B)12,876 12,028 11,280 11,103
Capital Employed (A – B)65,623 61,059 59,237 57,654
ROCE (%)22%22%20%19%
ROCE Calculation – Hindustan Unilever (HUL)

Note: 1 Crore =10 Mn

HUL Data source: Moneycontrol

Observation:

Hindustan Unilever’s ROCE improved from 19% in March 2021 to 22% in March 2024, indicating increased efficiency in utilizing its capital to generate profits.

Conclusion

In essence, ROCE provides a holistic view of how well a company is generating profits from its long-term funding sources (both equity and debt).

Investing ideas:

Companies with rising or stable ROCE tend to be attractive to investors, as they reflect efficient capital management and potential for long-term growth. On the other hand, companies with declining or volatile ROCE might signal inefficiency or difficulties in maintaining profitability.

Impact of Interest Rate Changes on Bond Prices and Debt Fund Returns

Understanding the Inverse Relationship Between Bond Prices and Interest Rates

Bonds pay a fixed interest, known as the coupon rate. When market interest rates change, the value of existing bonds adjusts to align with newly issued bonds at the current rates, leading to an inverse relationship between bond prices and interest rates.

Impact of Interest Rate Movements on Bonds and Debt Funds

1. Rising Interest Rates:

  • Effect on Bonds: When interest rates rise, new bonds are issued with higher coupon rates (e.g., 6%). This makes existing bonds with lower coupon rates (e.g., 5%) less attractive. To compensate for the lower yield, the price of these bonds must fall to offer a comparable yield to new bonds.
  • Example:
    If you hold a bond with a face value of ₹1000 and a coupon rate of 5% (₹50 interest annually), when new bonds are issued at 6%, investors will demand a lower price for your bond. To match the 6% yield, the bond’s price must fall below ₹1000.
  • Effect on Debt Funds: Since the prices of existing bonds fall, the Net Asset Value (NAV) of debt mutual funds also decreases, resulting in lower returns.

2. Falling Interest Rates:

  • Effect on Bonds: When interest rates fall, new bonds are issued with lower coupon rates (e.g., 4%). Existing bonds with higher coupon rates (e.g., 5%) become more attractive, increasing their market value.
  • Example:
    If interest rates drop and new bonds are issued at 4%, your bond with a 5% coupon rate becomes more desirable. Investors would pay more than ₹1000 for your bond, boosting its price.
  • Effect on Debt Funds: The increase in bond prices leads to capital gains for bondholders, resulting in higher returns for debt mutual funds.

Investment Strategies for Managing Interest Rate Risk in Debt Funds

Rising Interest Rate Scenarios:

  • Short-Duration Funds:
    In a rising interest rate environment, short-duration bonds or debt funds are preferable. These bonds mature quickly, allowing reinvestment at higher rates without significant price depreciation.
    • Why? Short-term bonds are less sensitive to interest rate changes, reducing the impact of rising rates on bond prices.
    • Funds to Consider: Liquid funds, ultra-short-term bond funds.

Falling Interest Rate Scenarios:

  • Long-Duration Funds:
    Long-duration bonds gain the most during falling interest rates because their prices increase more with the decline in interest rates.
      • Why? Longer-duration bonds lock in higher coupon rates, and their prices rise as newer bonds are issued at lower rates.
      • Funds to Consider: Gilt funds, long-duration debt funds.
    • Dynamic Bond Funds:
      These funds adjust the portfolio’s duration based on the interest rate outlook. Fund managers switch between long and short-term bonds depending on market expectations, allowing investors to gain in both rising and falling interest rate environments.

    Other Strategies:

    • Fixed Maturity Plans (FMPs):
      FMPs lock in yields for a fixed term, offering stable returns. They may not be as attractive in a rising interest rate environment, but in stable or falling rate periods, they provide predictable returns, insulating investors from market fluctuations.

    Key Takeaways for Investors:

    • Monitor the Interest Rate Environment: Investors should keep an eye on interest rate trends to adjust their portfolio allocations accordingly.
    • In Rising Rate Scenarios: Focus on short-duration funds or strategies that reduce interest rate risk.
    • In Falling Rate Scenarios: Consider long-duration funds or dynamic bond funds to capture gains from rising bond prices.
    • Use FMPs for Stability: In stable or falling rate environments, FMPs offer predictable returns with lower risk.

    By following these strategies, investors can improve their returns while managing the risk associated with fluctuating interest rates in debt mutual funds.