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Cents and Sensibility Guy Steele |
Rising rates
can mean different
things to investorsLong-term interest rates shot up significantly this summer. If you're an investor, what do these higher rates mean for you?
There's no one simple answer. How you respond to various economic events, such as a higher-rate environment, depends, to a certain extent, on your investments preferences, risk tolerance and financial objectives. Also, in looking ahead, you'd like to know if long-term rates will continue to climb -- and that's notoriously hard to predict. But it's interesting to note that the Federal Reserve seems committed, for the near future at least, to keeping short-term rates low -- a stance that could also help restrain increases in long-term rates.
But let's take a look at how changes in rates would affect your investments.
Let's begin with stocks. Rising interest rates are frequently accompanied by a strong economy, which generally translates into greater profits for companies -- and potentially higher stock prices.
On the other hand, higher rates mean that companies' borrowing costs will increase -- so it becomes more expensive for them to expand their operations. This added cost could affect stock prices.
In short, it's impossible to say, unequivocally, that rising interest rates are always good or always bad for stocks. Of course, the best thing to do is hold onto high-quality companies for the long term, regardless of interest rate changes. This is how you create the opportunity to build wealth.
Now, let's consider the impact of rising interest rates on bonds. Unlike with stocks, the effect of higher rates on bond prices is clear: when rates go up, bond prices drop. If you have a bond that pays 4 percent but market rates go up to 6 percent, nobody will want to pay full price for your bond. So, if you want to sell it before it matures, you'll have to offer it at a price that is less than you paid.
Of course, if you plan on holding your bonds until maturity, you might not care about rising interest rates and falling prices. No matter what market rates are doing, you can expect to receive regular interest payments. And, as long as your bond is of good quality, and has earned an investment grade credit rating by an independent rating agency, you can expect to receive the face value back when the bond matures. Additionally, insured bonds can increase the credit quality even more. (Keep in mind, however, that insurance does not eliminate market risk.)
But even if you do hold your bonds until they mature, you can take steps to blunt the impact of higher interest rates. How? By building a "bond ladder" -- a portfolio of bonds with different maturities. When your short-term bonds come due, you'll be able to reinvest them at a higher rate. And if rates start to fall, you'll still have your longer-term, higher-yielding bonds working for you.
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Guy Steele is a financial planner and head of the Pali Palms office of Edward Jones. Send planning and investing questions to him at 970 N. Kalaheo Ave., Suite C-210, Kailua, Hawaii, 96734, or call 254-0688
