If you’re unsure how rising interest rates may impact your investments and overall wealth plan, here’s what to look out for and how you can prepare accordingly.
For over two years, the Covid-19 pandemic has presented a variety of new challenges to our health, lifestyle, and the economy. As the pandemic wanes, we continue to feel the impact of ongoing labor shortages and supply chain disruptions.
One of the most pronounced effects of the pandemic in recent months is record-high inflation levels. As a result, the Federal Reserve announced their first interest rate hike since 2018 in March, and economists expect several more increases this year.
Indeed, many of us have grown accustomed to near-zero interest rates. If you’re unsure how rising interest rates may impact your investments and overall wealth plan, here’s what to look out for and how you can prepare accordingly.
#1: Rising Interest Rates and Your Real Estate Portfolio
The federal funds rate influences the prime interest rate, which lenders use to determine interest rates for credit cards and other loans, including mortgages.
Up until recently, mortgage rates have been relatively low for borrowers with strong credit. However, earlier this month, the average rate on the popular 30-year fixed mortgage crossed 5% for the first time since 2011 (except for two days in 2018).
For some people, rising mortgage rates may add to the pain of an already hot housing market. If you have the resources, you may want to consider paying off mortgage debt ahead of schedule to eliminate the expense entirely. Alternatively, refinancing may help you lock in a lower fixed rate before interest rates potentially soar higher.
#2: Rising Interest Rates and Your Bond Portfolio
In general, bond prices fall as interest rates rise (also known as interest rate risk). As governments and private companies issue new bonds at higher rates, old bonds become less attractive and therefore lose value.
Not all bonds are equally sensitive to interest rates. Interest rate sensitivity is measured by duration; the longer a bond’s duration, the more sensitive its value is to changes in interest rates. One way to reduce interest rate risk in your bond portfolio is to shift towards shorter duration bonds.
However, if you have a longer time frame to invest, you may not want to make any changes to your portfolio. As your bond holdings mature, you can reinvest them at higher rates in the future.
It’s also worth noting that higher yielding and lower quality bonds tend to be less sensitive to interest rate changes. Of course, these types of bonds can introduce other risks to your portfolio. So, be sure to do your homework first.
#3: Rising Interest Rates and Your Stock Portfolio
It’s cheaper for businesses to borrow expansion loans when rates are low, which is generally seen as favorable for the economy. On the other hand, the prospect of rising interest rates typically signals slower economic growth. This, in turn, tends to spook equity investors (at least temporarily).
At the same time, bonds and cash often become relatively more attractive as interest rates rise. This can cause stocks to lose value as demand shifts from equities to income-generating securities. And as personal debts become more expensive to service, consumers tend to spend less, further driving down stock prices.
You may not want to abandon your equity investments altogether. However, a diversified portfolio can help mitigate potential volatility as interest rates rise.
#4: Your Savings
With interest rates close to zero for the last several years, savers have earned virtually nothing on cash. Currently, the average savings account interest rate is 0.06%, according to Bankrate’s weekly survey of institutions.
One benefit of rising interest rates is that you may earn a higher rate of return on your cash. Just don’t expect a dramatic change immediately. Deposit rates are typically much slower to respond to changes in the federal funds rate.
Bottom Line: Don’t Panic
With rates at historic lows for so long and inflation at record highs, it’s no surprise that a new rate hike cycle is underway. If you have a disciplined wealth management plan, there’s no reason to panic. Interest rates tend to be cyclical and will eventually return to more normal levels.
If you don’t have a plan for your wealth, you may want to consider working with a trusted advisor like Sherwood Wealth Management. A long-term plan can help you navigate the inevitable ups and downs of the market. And it can help you successfully weather periods of uncertainty. To get started, please schedule a complimentary consultation.