Rising interest rates and your investment portfolio
Prices of goods, services and products continue to surge, and the cost of living in general has skyrocketed to its highest mark in decades. Amid record inflation levels, the Federal Reserve (the Fed), is expected to raise interest rates in an attempt to control inflation and keep the economy strong and stable. Many reports suggest the Fed is expected to raise interest rates multiple times this year.1,2,3
When interest rates rise, borrowing money becomes more expensive. And because interest rates affect house mortgages, car loans, credit card payments, and savings and investments, your overall financial wellness may be impacted.
Fortunately, certain strategies can help you navigate the current climate and keep your financial goals on track.
EVALUATE YOUR ASSET ALLOCATION STRATEGY
Diversifying your money across different kinds of investments can help provide stability when interest rates rise. Although one component of your portfolio might be facing pressure, when your portfolio is diversified, another component may be functioning as a buffer.
Holding bonds, in addition to stocks, is one way to diversify your portfolio. Bonds can provide stability by helping to balance against fluctuations in the stock market.
Keep in mind there are different types of bonds, so it’s important to review the bond funds in your portfolio to see if you’re well diversified:
- Corporate and government bond funds. Corporate bonds generally offer higher yields than government bonds because more risk is associated with corporate bonds. Government bonds are the more conservative option since they’re backed by the U.S. government and therefore less likely to default.
- Domestic and foreign bonds. Some bonds are issued in foreign markets and currencies. And because interest rates can differ from country to country, foreign bond exposure can help offset the impact of rising rates in the U.S. The value of foreign bonds can be affected by currency fluctuations, so it’s a good idea to fully understand any exchange rate risks.
- Term to maturity. Short- or intermediate-maturity bonds may be less impacted than longer-maturity bonds when rates start to rise.4,5 That’s because short-term bonds mature, or reach their end date, in less than five years. Long-term bonds take ten or more years to mature, so there’s a greater chance interest rates could change during that time period.
Bond sensitivity to interest rate movements is based on many key factors, including duration (a measure of interest rate risk), credit quality (the financial health of a bond issuer) and security type. Keep in mind that investing involves risk, and just because an investment has done well in the past doesn’t necessarily mean it will continue to do well.
THINK ABOUT YOUR LONG-TERM INVESTMENT STRATEGY
In addition to evaluating your asset allocation strategy, it’s a good idea to assess the big picture.
Human beings are hard wired to react quickly in stressful situations. However, you may want to resist the urge to drastically alter your long-term strategy based on any near-term monetary policy. Markets can be resilient. Keeping your long-term objectives in mind and diversifying your money across different kinds of investments can help you weather the ups and downs of the market.
1 CNBC, “Here are your best money moves before interest rates rise,” January 2022.
2 AARP, “How the Fed's Rate Hikes Will Affect Your Finances,” January 2022.
3 CNBC, “Rising interest rates could keep a choke hold on tech and growth stocks,” January 2022.
4 Compared to more highly rated securities, high-yield bond investment options are subject to greater risk, including the risk of default.
5 A bond fund’s yield, share price and total return change daily and are based on changes in interest rates, market conditions, economic and political news and the quality and maturity of its investments. In general, bond prices fall when interest rates rise and vice versa.
Asset allocation, diversification, dollar-cost averaging and/or rebalancing do not ensure a profit or protect against loss.
Bond prices generally fall when interest rates rise (and vice versa) and are subject to risks, including changes in credit quality, market valuations, inflation, liquidity and default. High-yield bonds have a greater risk of default.
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