The Bank of England increased interest rates to 3% this week. That’s the highest they’ve been since 2008.
Aggressive interest rate rises are likely to cause share prices to fall. But could higher interest rates be good news for investors with a long time horizon?
Share prices
The most obvious way that rising interest rates affect investors is that they bring down the value of assets. When interest rates are high, share prices are naturally lower.
Higher interest rates mean that cash and bonds offer better returns. As a result, it makes sense for investors to want higher returns from stocks as well.
Take Apple as an example. When interest rates are 1%, I might think that Apple shares are a good buy at a price that implies a 2% return.
If interest rates reach 3%, then buying Apple stock when it is priced for a 2% return makes no sense for me as an investor. As a result, I should buy only if the Apple share price comes down.
This makes it seem like higher interest rates are a bad thing for investors. But I think that the opposite is true.
Falling share prices generally mean higher returns. Mathematically, buying Apple stock at $130 can only be better than buying it at $150.
Higher interest rates are therefore a good thing for investors like me in one sense. They give us the chance to buy shares when they are trading at lower prices and offering higher returns.
Businesses
The impact of higher interest rates on investors goes beyond share prices, though. When interest rates are higher, that can make it difficult for companies to grow.
One way for businesses to grow is by taking on debt. When debt is more expensive, companies aren’t able to take opportunities for growth that they would otherwise have been able to.
This is a reason to think that higher interest rates are bad for business owners. But the story might not be entirely negative here.
Higher interest rates can also bring inflation under control. Rising inflation is a problem for consumers and, by extension, a problem for businesses.
When prices are higher, consumer budgets get stretched, meaning they can afford to buy less. This cuts into business revenues.
Inflation is also a problem for businesses, though. When their own costs are higher, companies either have to increase prices or face lower margins – neither of which is attractive.
If higher interest rates can bring down the effect of inflation, then it could be good news for businesses. As a result, shareholders could benefit from higher interest rates in the long term.
Interest rates
On balance, I think that higher interest rates could be good for me as an investor. The picture isn’t entirely straightforward, but I think that they can do more good than harm for me.
The most important thing, in my view, is that higher rates lead to better investment opportunities. I’m looking forward to buying stocks at lower prices as interest rates rise.
