With inflation hitting 40-year highs, the Federal Reserve has raised interest rates 11 times since March 2022, making these hikes the fastest cycle in history. This brings the federal funds rate to a target range of 5.25%–5.50%, making it the highest level of borrowing costs in over 22 years. Fed Chair Jerome Powell has stated that there may be another increase in interest rates this year. Here’s how rising rates can impact your investment portfolio.
1. Bond investments
Higher interest rates tend to harm bond investments. The value of many bonds decreases when interest rates rise because new bonds will pay a higher interest rate. This makes existing bonds less valuable in the eyes of investors, who can now get a better return on newly issued bonds.
Bonds with longer maturities will tend to see a bigger decline in value than those with shorter maturities. Short-term bonds are less risky. Since they mature faster, it gives investors an opportunity to reinvest their money at higher interest rates. In the short term, you may end up with a lower return as a bond investor.
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2. Stock investments
Stock investments can be impacted by interest rate hikes as well. For example, rising rates can cause borrowing costs to rise for companies, reducing their profits. This can cause stock prices to decline.
However, the impact on stocks is not always straightforward. Higher interest rates can also mean a strong economy, which can boost stock prices. Additionally, some stocks may be relatively insulated from the effects of rising rates, such as those in non-cyclical industries like healthcare or utilities. Typically, value stocks tend to hold up better than growth stocks during times of rising interest rates.
3. Real estate investments
Another asset class impacted by interest rates is real estate. When interest rates rise, mortgage rates also tend to rise, making it more expensive for buyers to buy a home. This can lead to a slowdown in the real estate market.
However, real estate investments can be a good hedge against inflation. Rental rates can go up thanks to inflation, thereby increasing the income generated by property investments. Real estate investments such as REITs (real estate investment trusts) may be affected differently, though.
REITs tend to hold long-term leases with tenants, so their rental revenue streams are less affected by short-term interest rate changes. Additionally, a strong economy can help boost demand for properties, reducing the negative impact of rising interest rates.
Precious metals such as gold act as a hedge against inflation. Investors tend to move toward precious metals as a store of value when inflation fears are high. If interest rates rise, it could be an excellent opportunity to invest in commodities and precious metals for the short term. This is because these investments tend to increase in value during inflationary periods.
5. Cash, CDs and savings accounts
Lastly, it’s important to consider cash investments, such as CDs and savings accounts. When interest rates are up, savings accounts generally provide a higher yield. If you are looking for a risk-free investment with a relatively stable return, a high-yield savings account could be a good choice.
The downside is that the rate of return may be much lower than inflation, so you may actually be losing purchasing power by keeping money in these accounts.
How to invest during rising interest rates
As interest rates continue to rise, many investors may feel nervous and unsure about how to invest. The best course of action, however, is to stay the course and think long term. Rather than panicking and making rash decisions, it may be wise to continue making periodic investments and avoiding attempts to time the market.
Additionally, it may be a good idea to pay off any outstanding debts, as credit card interest rates will likely increase with Fed rate hikes. By staying focused and keeping a level head, investors can weather the storm of rising interest rates and come out ahead in the end.
The effects of another Fed rate hike on your investment portfolio can vary depending on the asset classes in which you’re invested. Bond investments may see declines in value, while stock investments can be impacted in more complex ways. Real estate investments can be more resilient amid rising rates if the economy remains strong. As with any investment strategy, it’s important to keep a long-term perspective and not make rash decisions based on short-term market fluctuations. You don’t want to make any costly mistakes!
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