May 6, 2023
Interest rates impact more than your borrowing costs. Here's how higher interest rates can affect your investment portfolio.
I was looking over my bank account while doing my taxes the other day and I was shocked by how much my interest costs went up in just a few months. This should have been no surprise to me. Interest rates have made up most of the financial news these past few quarters as central banks raised interest rates to lower inflation. We all know that interest rates going up will have an impact on personal debt and cash flow. But interest rates impact more than our budget. Here’s a little insight on the impact interest rates can have on your investments.
A traditional investment portfolio is made up of stocks and bonds and possibly some cash or cash equivalent. Each of these investment assets can react differently as economic conditions change. Investors try to use current and expected economic conditions to predict how an investment might perform in the future. One of the investments most sensitive to interest rate changes are fixed income investments like Guaranteed Investment Certificates (GICs), treasury bills, bonds and even savings accounts. All these investment products are linked to bond markets. As rates rise, so do the yields in bond markets. When yields rise, the interest paid by investments like GICs and savings accounts rise as well. However, bond prices and bond yields have an inverse relationship, meaning that as one goes up, the other goes down. This is due to the fact that when interest rates rise, the yield on newly issued bonds will be higher, making them more attractive to investors. As a result, existing bonds that are paying lower interest will see their price drop because investors will want a similar yield to the one available with the newly issued bonds. Any investor who owns bonds in their portfolio will likely see some losses on these bonds during a period of increasing interest rates. When interest rates fall, bond prices usually go up because of lowering yields, which in turn lowers GIC and savings rates for investors.
Interest rates will also impact stock markets. Since stock prices reflect the potential future earning potential of a company, interest rates can have a considerable impact on stocks as well. As rates rise, the cost of borrowing for companies goes up which makes it more difficult and costly for them to borrow for expansion or improvements. This affects their ability to earn profits. And with higher interest costs, both corporate and individual consumers have less available to spend which could mean less revenue for the company. Companies with rising interest costs and lower expected revenues will typically have their share prices impacted negatively. Investors who own stocks in their portfolios can see the value of these investments fluctuate as the market determines the severity of each company’s sensitivity to interest rates.
This is a high-level overview of how traditional investments can react to changes in interest rates. There is much more depth and inter-connectedness between interest rates and investments. No one really knows exactly where interest rates are going in the future, nor does anyone know exactly how investments will react to future rates. That’s why diversifying across different investments with various sensitivity and correlation to interest rates and other economic cycles is key to an investor’s long-term success.
Investors looking to make sound investment choices must consider many factors including the purpose of the investment, how long it will remain invested and their tolerance for volatility and risk. I would encourage anyone thinking of making drastic changes to their investment portfolio because of the current interest rate environment to make sure they are carefully considering all of the above and more before making any decisions.
Author:
Marcel LeBlanc, CFP®, CIM® is a Financial Planner and Associate Portfolio Manager with Louisbourg Investments. You can find more from him on Facebook and LinkedIn. Comments or questions may be submitted to Marcel at marcel.leblanc@louisbourg.net, or he may be reached at (506) 383-5204
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This writing is for general information purposes only and is not intended to provide legal, accounting, tax or personalized financial advice. If you are not sure how to proceed with a request for further information, seek help from a professional. Any opinions expressed are my own and may not necessarily reflect those of Louisbourg Investments.
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