There aren’t many “sure things” in the investing world, but there is one thing investors can count on: Over time, interest rates will rise and fall.
Interest rate changes affect investments in different ways. Understanding the potential effect of fluctuating rates on the economy and your investments may help you make better investing decisions and build a portfolio that can withstand the ups and downs.
A Look at Stocks
Interest rates often rise when the economy — and generally, corporate earnings and stock prices — is growing. That should be good for stocks, but a number of things can curtail growth. Rising interest rates mean companies pay more to borrow money, resulting in reduced earnings. When borrowing costs rise, consumers may limit spending on big-ticket items, and that may impact the housing, automobile, and other industries. And the higher yields on fixed income investments may encourage investors to put more money into bonds and less into stocks.
Some industries are less affected by interest rate fluctuations than others. Companies that produce consumer staples tend to remain stable no matter what the economy and interest rates are doing because consumers still need to buy these items
The Effect on Bonds
Typically, the prices of previously issued bonds fall when interest rates rise, making rising rates the bane of fixed income investments. Since newly issued bonds pay interest at a higher rate, investors generally won’t buy older bonds unless they’re sold at a discount to compete with the prices of the new issues.
That doesn’t mean investors should give up on bonds when interest rates are rising. However, investing in bonds with shorter maturities of one, two, or five years may be the best approach. Since money isn’t tied up for very long, investors will be able to take advantage of potentially higher rates as bonds mature.*
In the Bank
When interest rates rise, savers earn a higher yield on money in savings accounts, certificates of deposit, and other cash alternative investments.
* Prices of fixed income securities may fluctuate due to interest rate changes. Investors may lose money if bonds are sold before maturity.
Back to Articles