Will Your Portfolio Suffer As Interest Rates Rise?

Interest rates won’t remain at historic lows forever — great news for savers.

However, for investors, higher interest rates could be bad news.

Many moving parts

Ever investor should be aware how higher interest rates will affect their portfolio.

Bond investors are likely to suffer the most if they’re unprepared. Bonds have been one of the best-performing asset classes over the past five years as investors, desperate for yield, have poured money into the asset class. 

This influx of cash has sent bond price surging and yields — which move inversely to prices — sliding.

However, higher central bank interest rates will push up the yields on bonds, as investors sell up in search of other opportunities elsewhere. Consequently, bond prices will fall, eroding the capital value of bonds. 

Defensive losses 

Unfortunately, research shows that defensive stocks act in a similar way to bonds when interest rates start to rise. 

You see, just like bonds, defensive stocks have been in demand over the past few years. Investors have been forced to push cash into higher yielding assets, to achieve a better return on their money.

Nevertheless, just like bonds, when interest rates start to head higher investors sell their defensive stocks in favour of safer assets.

All in all, as interest rates head higher, defensive stocks and bond prices will come under pressure. But it’s not all bad news. 

Not all bad news

Traditionally, stock market bulls have interpreted rising interest rates as a sign that an economic recovery is starting to get underway. 

For growth investors, this is great news. As economic growth starts to recover, sales should pick up and earnings should push higher. Ultimately, higher interest rates are a sign that good times are ahead for growth investors. 

Time to prepare? 

So, should investors prepare for higher rates by selling defensive investments and using the cash to buy growth stocks? Not necessarily. 

Indeed, the market has been speculating for several years that higher interest rates are just around the corner. And as of yet, few analysts have correctly predicted a rate hike.

Moreover, trying to time the market can result in costly mistakes if you make the wrong decisions. 

Nonetheless, after the rally in bonds and defensive stocks over the past five years, it might be wise to take some cash off the table. Although, it’s up to you whether you choose to reinvest this cash or hold it for a rainy day. 

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.