What to do if interest rates rise?

Interest rates have been very low for many years. There has been talk of interest rate hikes, which is evident in the bond market. What do you do with your money if interest rates go up?

There are several aspects of your money to consider when asking this question. The first area is debt. When interest rates rise, the cost of paying down any type of debt will increase on average. The exception may be credit cards, but the rate on this type of debt is very high to begin with. If you have debt, prioritize it over debt that has a fixed interest rate or a variable interest rate. Fixed-rate debt is usually mortgages or loans with a time limit determined by the debt contract. Variable rate debt would be lines of credit or a mortgage that has a variable rate. Variable rates generally need to be paid first in case of rate increases, as rates will be affected sooner. Fixed rates can be left until renegotiated, but you need to think about how you can pay for the new rate when it goes into effect. If these fixed rate loans are years in the future, this consideration can be left up to 1 or 2 years before the current rate expires. The next step is to choose the highest variable rate loans and pay them off first. I would include credit cards on this list as they tend to have the highest rates for most people. If you currently have variable rate loans, you may want to consider locking in a fixed rate for a longer period of time. If you absolutely need a fixed payment each month and can’t afford a higher interest rate, this option would be a good idea for you.

The next area is your cash investments. Rising interest rates are generally good for savings accounts and GICs, as these would pay more in interest. If you have money in a bank account and you have no other uses for the money, you should probably leave it in the bank account or put it in a high-interest savings account that would pay more money as rates rise. Some bank accounts don’t pay much interest, and this would likely stay the same even if rates start to rise. If you have fixed-duration GICs, you’ll usually have to wait until they expire before you roll over the money. You are likely to get a higher rate at that time, if rates have gone up since the expiration date. If you have GICs that are not locked or can be redeemed at any time, you may want to redeem them when you see published rates are higher than the rate you are currently receiving. Make sure that when you renew this type of GIC, the new investment is still redeemable and the holding period is short before cashing out. In the event of interest rate increases, you may be required to maintain renewal periods of this type of GIC as rates increase to take advantage of the higher rates. This process usually costs no fees and contains no additional risk, so renewing as interest rates rise is generally a good idea in this situation.

The next area is the fixed income part of the investment portfolio. There are certain investments that will be affected more than others in the field of investments. The first thing to notice is “what interest rate is moving higher?” There are rates for deposits of 1 day, 1 month, 6 months, 1 year and so on up to 30 years. The Bank of Canada or the US Federal Reserve will announce the overnight loan rate, but the other rates are determined by the markets in which they operate. Sometimes overnight rates may not change, but long-term rates can change based on what the bond market perceives to be the direction of the interest rate. This happened recently, as the US 10-year bond rate increased, but the overnight rates did not change. If you have fixed-income investments, including bonds, mortgages, or any type of debt where you receive interest instead of paying it, you would be affected by a change in rates. This is because the interest rate is the “price” of your investment, and if the rate goes up, the price of the debt security will go down. This means that “it is cheaper to get the same interest received as when interest rates were lower.” If you hold this investment until it matures, the prices will change, but you will not be affected because you have the individual bond. If you have a pool of bonds or mortgages, such as a mutual fund, the values ​​will keep changing and therefore you cannot assume that you will get a certain amount of money on a maturity date. Depending on the interest rate that rises, you may or may not be affected. If you hold the 10-year US Treasury bond and the interest rate on the 10-year US bond increases, you will be directly affected. If you hold the 30-day US Treasury bill at the same time, this value will not be affected unless the 30-day rate has also increased.

As for the stock portion of the investment portfolio, interest rates will generally have an effect on the stock, but the effect varies depending on the type of company it is. It should be noted that higher rates generally take more money out of people’s pockets, which reduces economic growth all other things being equal. This is like saying that a low tide lowers all boats, but not equally. Stock markets in general tend to go down when interest rates rise, but not all stocks are affected in the same way. The more the company is affected by debt and interest rates, the greater the reaction of the stock price to a movement in the rate. For example, a bank that makes money on mortgages and issues interest on GICs would make less profit at higher rates. An industry that is highly leveraged, such as a hedge fund, would find borrowing more expensive, limiting the ability to amplify profits from borrowing. Home builders and car manufacturers generally decline when interest rates rise, because homes and cars become more expensive for the consumer and sales will decline. If you already have a home or car, these items will also cost more to maintain. The same trend tends to occur with industries that rely on homes and cars: furniture, appliances, large electronics producers, renovations, etc. If the industry is not affected by interest rates, such as perhaps food, utilities, water, or companies that work for fixed costs that are paid up front, these actions would have a lot of effect. There are also some exceptions that increase when rates increase: these would be companies such as alcohol, tobacco, basic food producers, utility companies, or gambling companies. When the economy takes a turn for the worse, which often happens when interest rates rise, successful businesses offset the economic slowdown.

What about real estate? As noted above, higher interest rates will tend to make real estate more expensive because loans are often associated with the purchase and maintenance of real estate. The correlation isn’t always direct or instantaneous, which means that sometimes rates can go up for months before real estate prices show any effect. Unlike the stock or bond markets, people take more time to trade real estate because it is less liquid and because a real estate transaction is generally thought through much more because it is quite expensive for most people. Exceptions may be rental units, apartment buildings, foreign real estate in areas where interest rates are waived, nursing homes, medical facilities, or government-owned real estate.

What if I own tangible assets like art, precious metals, collectibles, etc.? These types of goods will be driven by perceptions within their markets. If a large number of wealthy people own art, and have paid cash for their art, and have a lot of disposable income and no debt, interest rates probably won’t have any effect. The same idea can be applied to precious metals and collectibles. If the reason interest rates are rising is due to inflation, these assets may increase in price along with inflation. Since these are physical goods, they actually offset inflation. If interest rates rise due to economic rebalancing, there may be no effect for these types of assets.

In the case of annuities, pension payments, CPP or OAS payments, these can be considered in the same way as bonds. The problem here is that if you are receiving the annuity and the company paying you the money has guaranteed a fixed amount each year, an increase in the interest rate would affect the issuers ability to pay. Only if there is a drastic change in the condition of the company as a result of an increase in interest rates, will this have any effect on the payments received. If you receive not payments, but a full value of these payments, which is similar to the price of a bond, then you may lose money because higher rates would drive the value of that payment down.

As you can see, what to do with your money will depend on what it is invested in and how interest rates would affect it. As with most things, there are no absolutes or guarantees: there are generalities with some exceptions that may exist. This article provides a starting point to dig deeper into what you may need to be more prepared for potential outcomes.