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 off any type of debt will rise 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 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 the event of a rate increase, as rates will be affected sooner. Fixed rates can be left until they are renegotiated, but some thought needs to be given to how the new rate can be paid when it comes 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. Higher interest rates are generally good for savings accounts and GICs, as they would pay more 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 go up. Some bank accounts don’t pay much interest, and this would probably stay the same even if rates start to rise. If you have fixed duration GICs, you will usually have to wait until they expire before reinvesting the money. You’ll likely get a higher rate at that time, if rates have gone up since the due 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 the posted 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 rising interest rates, you may need to maintain renewal periods for this type of GIC as rates rise to take advantage of higher rates. This process typically costs no fees and carries 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 in duration. The Bank of Canada or the US Federal Reserve will announce the overnight lending rate, but the other rates are determined by the markets in which they operate. Sometimes overnight rates may not change, but long-term rates may change depending on what the bond market perceives as the direction of the interest rate. This happened recently, as the US 10-year bond rate rose, but overnight rates did not change. If you have fixed income investments, including bonds, mortgages, or any type of debt on which you receive interest rather than pay 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 would go down. This means that “it is cheaper to get the same interest received than when interest rates were lower”. If you hold this investment until it matures, the prices will change, but you won’t be affected because you have the individual bonus. If you have a group of bonds or mortgages, such as a mutual fund, the values ​​will continue to change, and therefore you cannot assume that you will get a certain amount of money by a maturity date. Depending on what interest rate goes up, you may or may not be affected. If you have 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 stocks, but the effect varies depending on what type of company it is. It should be noted that higher rates generally take more money out of people’s pockets, reducing 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 there are increases in interest rates, but not all stocks are affected in the same way. The more the company is affected by debt and interest rates, the greater the stock price’s reaction to a rate move. For example, a bank that makes money on mortgages and issues interest on GICs would make less profit with higher rates. An industry that is highly leveraged, such as a hedge fund, would find loans more expensive, limiting the ability to amplify profits from loans. Home builders and automakers generally decline when interest rates rise, because houses and cars become more expensive for the consumer and sales will decline. If you already have a house or a car, it will also cost more to maintain these items. The same trend tends to occur with industries that depend on homes and cars: furniture, appliances, large electronics producers, renovations, etc. If 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, staple food producers, utilities or gambling companies. When the economy gets worse, which often happens when interest rates rise, companies that prosper 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 is not always direct or instantaneous, meaning that rates can sometimes go up for months before house 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 much more thought through because it is quite expensive for most people. Exceptions may be rental units, apartment buildings, foreign real estate in areas where interest rates are not current, 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 plenty of disposable income and no debt, interest rates are unlikely to 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 goods may rise in price along with inflation. Since these are physical goods, they actually counteract 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 that pays you the money has guaranteed a fixed amount each year, an increase in the interest rate would affect the ability of the issuers to pay. Only if there is a drastic change in the company’s condition as a result of a rise in interest rates will this have any effect on the payments received. If you receive no payments, but rather a total value of these payments, which is similar to the price of a bond, then you stand to 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 a few exceptions that may exist. This article provides a starting point for a deeper dive into what you may need to be more prepared for possible outcomes.