For the past two decades, markets have experienced a falling interest rate environment. In fact, interest rates have hit historically low levels within the less 12 months alone. This has made the cost of borrowing extremely low and has created steady growing returns across the equities. Today, we are starting to see the multi-decade trend turn as interest rates begin to rise. So how will this affect your investments? Here’s a look at five ways rising interest rates will change the way you approach your investing strategy.
1) Bond Prices Drop as Interest Rates Rise
The first thing that happens during a rising interest rate environment is a dramatic fall in the price of bonds. You’ll find the biggest effects in long-term bonds. Investors with a bond-heavy portfolio will diversify into other investments which have a better rate of return.
2) Cost of Borrowing Goes Taking Away Spending Power from Consumers
When interest rates move higher, the cost to borrow money becomes more expensive. That makes it harder for consumers to make major purchases and spend money on discretionary items. This will cause discretionary stocks to underperform the markets.
3) Cyclical Industries Become Much More Attractive
A world of rising interest rates tends to turn the markets upside down. You will notice that some “boring” stocks become quite exciting as they outperform the markets. As an example, financial, industrial, and energy sectors will start to outperform tech and discretionary stocks.
4) Diversification Becomes More Critical
When inflation is under control, you could get away with putting most of your money in the stock market. After all, the S&P 500 returns about 10% a year during low inflation times. However, the markets tend to have unreliable returns in a high-interest rate environment. A portfolio that holds assets across different classes - stocks, bonds, precious metals, and real estate - will tend to hold up better and experience less volatility.
5) Savings Accounts and CDs Can Be Used to Buffer Market Volatility
You may find it laughable to consider your savings account or certificates of deposits (CDs) as part of an investment strategy. However, in a high-interest rate world, you may want to consider using your local bank as part of your investment strategy. In 1980, banks were paying a savings rate of up to 8%, actually outperforming the S&P 500. In 1981, a 3-month CD paid an 18.3% APY! Be sure to check out your bank's savings and CD rates as interest rates begin to rise.
Preparing for a World of Rising Interest Rates
When interest rates rise, it is time to think differently. It’s a smart idea to understand how rising interest rates affect everything from stock market returns to consumer purchasing power. By diversifying into different asset classes will likely provide lower volatility and better returns. 1. https://time.com/nextadvisor/mortgages/mortgage-rates-history/