Which investments are affected by higher interest rates?

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Q. I know some investments are affected by higher interest rates. Which ones?
— Investor

A. You’re correct that investments can be affected by changes in interest rates.

Different investments will see a different impact.

Recently, we have seen interest rates climb to levels not seen in some time, and that has created some negative environments for some investments in the short term, but also have created some potential opportunities for other investments in the long term, said Michael Cocco, a certified financial planner with Beacon Wealth Partners in Nutley.

He said regarding the stock market, higher interest rates can create challenges for a couple of different reasons.

“First, since the stock market is largely predicated on the underlying companies’ earnings — and growth of these earnings — higher interest rates can increase the borrowing costs for these businesses, which can have an effect on their profits and their ability to grow,” Cocco said.

From a stock valuation standpoint, when interest rates were super low and the banks were not offering much in terms of interest in traditional bank accounts, investments in the stock market look even more attractive than usual, he said.

When interest rates become more meaningful, some investors may be happy with those returns, and not be as willing to take on investment risk in the stock market, even if it means the potential for higher long-term returns, Cocco said. Conversely, higher interest rates may have a longer-term positive effect on the stock market, as combating high inflation through rising interest rates can lead to more sustainable economic growth, which can help create more stability over the long term.

In the bond market, in the short term, bond prices typically move inversely to interest rate changes, Cocco said.

“In a rising interest rate environment, as bonds mature and new bonds are issued — or being bought and sold within a bond mutual fund — these newer bonds could pay more interest due to the higher interest rates,” he said.

Real estate typically becomes less attractive in higher interest rate environments, Cocco said. That’s because financing is a large part of that investment world, and higher borrowing costs cut into the profits of investment real estate and can also lead to less demand, lowering real estate prices, he said.

‘The complexities of how interest rates affect multiple types of investments in positive and negative ways is why one’s personal goals, time horizon, and tolerance for risk are very important when deciding how and where to invest, and not just the level of interest rates at a given time,” he said.

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This story was originally published on Nov. 13, 2023.

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