Why are interest rates rising?
When inflation rises rapidly, it creates a cascade of price increases, the main effect of which is that the value of your money decreases, and so does your purchasing power.
To limit inflation, central banks raise their leading rates so that other lending institutions will in turn raise their prime interest rates. Because it then costs more to borrow money, consumers and businesses are less likely to ask for financing and therefore they decrease their spending.
On a larger scale, this reduced borrowing and consumption in turn causes reduced investments and reduced demand for goods and services. These changes slow down the economy and help to contain inflation.
What are the effects of rising interest rates on your finances?
The primary effect of rising interest rates is an increase in the cost of repaying your variable-rate loans, for current loans, renewals and any new loans you take out:
Fixed-rate mortages: If you have a fixed rate for a few more years, you will not see any impact for the rest of your contract. However, when you renew, your payments will increase according to the new mortgage rates.
Variable-rate mortgages: Based on your contract, your lending institution may increase your payments or reduce the amount applied to the repayment of your capital.
Student loans: If you are paying off a student loan, the interest on your payments will increase based on the increase in the rates.
Vehicles: Rates for purchasing and renting vehicles will also increase.
Other loans: Other loans may also become more expensive, such as investment loans or RESP loans.
To mitigate the impact of rising interest rates, some people may need to review their budgets, check options offered by other lenders or think twice before taking out a loan.
Don’t hesitate to talk to your financial security advisor if you’re worried about the impact of rising rates on your finances.
Are there advantages to rising interest rates?
Yes! Some investment instruments can benefit from rising interest rates. For example, High Interest Savings Accounts (HISA) and Guaranteed Interest Funds (GIF) provide better returns in this context.
Also, the portion of your portfolio invested in these instruments allow you to:
- reduce risk associated with volatility
- benefit from a fixed interest rate, as opposed to bonds or equity funds that are prone to fluctuation
- improve your portfolio diversification
Because HISA and GIF returns are predictable, they are attractive investment options for an investor who would like to keep money temporarily sheltered from volatility until it can be reinvested elsewhere.
What is the impact of rising interest rates on the stock market?
Rising interest rates can sometimes cause certain securities to decrease in value. There are several reasons for this potential bearish effect on the markets. Here are some examples:
Because rising interest rates increase the cost of financing for companies, investors expect their returns to fall, which influences their perception of share value downwards.
The more modest growth prospects raise fears of a slowdown in the economy and in expected profits.
Some investors may turn to less risky assets, such as bonds, securities or other investment instruments that benefit from rising rates to offer better returns.
If you have investments in the stock market during periods of rising rates, don’t forget that staying invested for the long-term is always a winning strategy. The probability of losing money with an investment horizon of 20, 10 or even 5 years is low.
Diversifying your portfolio and periodic lump-sum investments are some of the best strategies to use to reduce the risk of stock market volatility by taking advantage of market lows. Talk to your advisor.
Do rising interest rates have an impact on bonds?
Yes! Bond returns are directly related to the current interest rates. Each change in interest rates changes the price of bonds, which tends to fall when interest rates rise and to rise when interest rates fall.
Here’s how this works:
- Bonds compete in the bond market based on the income they provide. The higher interest rates are, the higher the income from bonds is, and vice versa.
- When interest rates increase, bonds offering income lower than the current market must lower in cost to offer a total return comparable to that of newly issued bonds. These adjustments can mean the whole bond market reduces in value when rates increase rapidly.
- During periods of high rates, bonds with long maturities are hit harder than short-term or floating rate bonds because the lower income they provide is fixed for a longer period.
This post was originally posted on the Investia Financial Services Inc. blog, the original post can be found here.
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