Fixed-income investments are a crucial part of a solid financial foundation. Fixed-income investments are virtually risk-free (if you are dealing with a solid institution) and your returns are guaranteed. However, there are rate risks involved, i.e. upon maturity of your investment, the rates may change and sometimes downwards. If you have no other source of income apart from your interest income, then you will be adversely affected when rates go down.
Here are ways you can manage rate risks to minimize downward fluctuations in your interest income.
Acquire financial education
Your first line of attack in managing rate risks is to acquire financial education. This involves gaining knowledge of various available investment vehicles in the money market and keeping up to date with current market trends and rates. Don’t just park our money and walk away. Keep an eye on it to ensure that it meets your investment objectives.
Read books on personal finance, financial magazines, and newspapers, and watch TV stations that cover the area of the market you are interested in. Keep expanding your knowledge to become abreast of options available to you to meet your financial goals.
Move your money to another vehicle
If you placed your money in fixed deposits and rates go down, you can switch to treasury bills or bonds. Be up to date on current market trends as mentioned above and move your funds around to get the best rates as required. Don’t simply park and forget your money.
This is where financial education helps. With the knowledge gained, you know what your options are and can move your funds accordingly.
Give yourself a buffer
Do not make long-term financial projections based on current rates. If rates go up, that is fantastic. You have a windfall. However, if it goes down, you are in trouble. All your projections will go out the window. Give yourself a buffer. If you are currently getting 10%, you can make forward projections based on 5% or something within that ballpark.
The Nigerian government which makes most of its income from crude oil does not prepare annual budgets based on current oil prices. There is always a buffer, sometimes up to $30 off current oil prices. Income above official projections is saved in the excess crude oil account. That is a way to manage rate risks or price fluctuations.
Diversify your portfolio
Another way to manage rate risks is to diversify your portfolio. Diversifying your portfolio in this context means investing in other markets outside of the money market. For example, you can invest in real estate or precious metals. In terms of real estate, it means investing for rental income. If you have good tenants, your income is stable and goes up every two years when rents go up.
Hoping from one market to another is not a very good idea and can backfire. Some people flee the money market when rates crash and run to the stock market or real estate market. You need to have some of your portfolios in liquid cash. The money market is the best place to invest such funds. If you need money urgently, it may not be a good time to sell your shares or investment property. Buyers are on the lookout for desperate sellers who need the money. When they smell your desperation, they offer you a below-market price.
Having your emergency funds in the money market means you can access them when the need arises, without shooting yourself in the foot. A rate crash in the money market is not a sufficient excuse to liquidate your emergency funds and leave yourself naked. Nations hold their foreign reserves in cash. So should you.
Explore offshore markets
You are not married to your local market. If money market rates crash in Nigeria, you can move your funds to Ghana, Kenya, etc. To be able to do that, you have to be knowledgeable about foreign markets and current trends in those markets. You also have to factor in exchange rate risks. You make a good deal on paper and have your margin slashed or wiped out due to exchange rate fluctuations.
If you move your funds offshore, you are trading in two markets simultaneously – the money market and the foreign exchange market (forex). If you know what you are doing, you can leverage forex to increase your returns.
Foreign investors are not ghosts from another planet. They are humans like you and me that invest across borders, moving their funds from country to country at the click of the mouse. This movement triggers market movements across the globe. Interestingly, foreign investors are usually the first to flee in a market crash. Their exit usually signals an impending crash. You don’t have to be an institutional player to play at this level. You simply need to know what you are doing and the risks involved.
Image: budgeting.thenest.com
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