How Could Rising Interest Rates Impact Your Wealth?
As seen on the WJAR NBC 10 Smart Advice Series
It's important to understand how movements in markets can affect your wealth management goals. Here's a brief summary of some of the effects of rising interest rates on investments, and how your strategies may need to change with the financial environment.
Generally speaking, rising interest rates tend to reduce the market value of bonds that investors currently hold. As market rates go up, fixed income investments purchased in a lower rate environment may not earn as much as new money invested today. As a result, if an investor chooses to sell those investments, they may not be worth as much as when they were purchased.
But for investors who hold their bonds until they mature, rising rates are not necessarily a cause for concern. Price fluctuations won't affect a bond's regular coupon payment, and shouldn't affect the issuer's ability to pay back principal at maturity. Rising interest rates also can provide fixed income investors with an opportunity to earn higher yields.
Bond mutual funds share some characteristics of individual bonds, but with some important differences. Bond funds typically hold underlying bonds from many issuers, with varying terms to maturity. This offers diversification and can be an efficient way of investing compared to owning individual bonds, but unlike individual bonds, most bond funds do not have maturity dates. Fluctuations in the value of the underlying bonds can cause immediate changes in shareholder returns. In addition, the overall investment return in bond funds can be impacted by the sale of underlying bonds to fund withdrawals by other investors.
Usually, the yield on fixed income investments increases with the period of time you are willing to invest. However, the longer the term, the more sensitive the market value of the bond or bond fund will be to movements in interest rates. Fixed income investors should balance their desire for higher interest payments with their tolerance for changes in market value. If you seek a balance between low price fluctuations and higher yields, consider choosing a mix of short, intermediate and long term fixed income investments.
Stocks and Stock Mutual Funds
Prices of individual stocks and stock mutual funds are not necessarily directly related to rising interest rates, but can be impacted in a few ways. For example, a sharp rise in interest rates could lower the valuation multiple that investors are willing to pay for a stock’s future earnings, which in turn could lower stock values. Also, if interest rates rise, opportunities to earn higher yields on fixed income investments might cause a shift away from stocks. Depending on the industry, interest rates can have varying impacts on the stock issuer. For instance, stocks favored for their dividend payment rather than their growth potential, like some utilities, could decline in value if rates rise significantly, while others whose earnings may benefit from higher interest rates, like financial services companies, could rise in value.
Since movements in interest rates can affect stocks and bonds differently, you should manage your investment allocation to meet your individual needs and objectives as market conditions change. For smart advice that’s focused on your unique financial goals, contact Washington Trust Wealth Management at 800-582-1076 or visit us at www.washtrustwealth.com.
The views expressed here are those of Washington Trust Wealth Management and are subject to change based on market and other conditions. Investment recommendations and opinions expressed in these reports may change without prior notice. All material has been obtained from sources believed to be reliable but its accuracy is not guaranteed. Investing entails risk, including the possible loss of principal. Stock markets and investments in individual stocks are volatile and can decline significantly in response to issuer, market, economic, political, regulatory, geopolitical, and other conditions. Fixed Income investments, including floating rate bonds, involve risks such as interest rate risk, credit risk and market risk, including the possible loss of principal. Interest rate risk is the risk that interest rates will rise, causing bond prices to fall. Past performance does not guarantee future results. The information we provide does not constitute investment or tax advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell any security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. Please consult with a Washington Trust Planning Officer, attorney or tax professional regarding your specific investment, legal or tax situation.