Interest rates, whether they are rising or falling, are likely one of the most discussed subjects in the investment world. You can hardly avoid interest rates. Flipping open any major newspaper or browsing expert views, you are highly likely to land on those two words somewhere.
As much as it’s a widely covered topic, many investors may still be confused about the implications of rates on global markets, and more importantly their investments. So, what exactly are the impacts of rates on our money?
How do US Fed interest rates affect you?
Impact on bonds
Interest rates and bond prices have an inverse relationship. This means that when interest rates rise, bond prices decrease and when interest rates go down, bond prices go up. This is commonly dubbed as the bond see-saw relationship.
This is because the income generated by a bond (through its coupon payments) determines its price. When prevailing interest rates rise, existing bonds become less valuable as their coupon payments are lower compared to newly issued bonds available in the market. The prices of these older bonds decrease, and they would consequently be trading at a discount.
Conversely, when current interest rates fall, older bonds with higher interest rates increase in value. Investors holding these bonds can sell them in the secondary market at a premium.
For example, let’s say there’s a bond with a $1,000 face value that pays $50 annually, giving a fixed interest rate of 5%. It was issued when prevailing interest rates also stood at 5%.
Now, if a year later, interest rates rise to 7%, investors can buy a new bond for $1,000 and be paid $70 per year for holding it. This means that the old bond, which pays only $50 per year, has to be worth less. The bond would be sold at a discount.
On the other hand, imagine that interest rates decline to 1%. A new bond bought for $1,000 would only pay a $10 yearly return to bond investors. Consequently, the previous bond, which gave $50 annually, becomes appealing, making the market bid this up so it trades at a premium.
Read more: Why bonds can be an essential part of your portfolio
Impact on stock markets
In theory, interest rates and the stock market move in opposite directions. High interest rates hurt stock prices in two ways.
Firstly, when interest rates rise, it becomes more expensive for companies to borrow money. This leads to a decrease in share prices because higher borrowing costs reduce the available cash for companies to re-invest in their businesses and growth initiatives.
Secondly, higher interest rates also mean the discount rate increases in valuing future cash flows and ultimately, the valuation of a business, causing stock prices to fall.
Conversely, when interest rates fall, the stock market generally experiences an upward trend as borrowing costs decrease and the present value of future cash flows increases. This is epitomised by a decade of low- and near-zero interest rates after the Global Financial Crisis.
Some companies benefit from interest rate hikes. For example, banks can make more money when interest rates rise as they can charge higher interest when people borrow money from them.
Impact on consumers
Changes in the federal funds rate impact other interest rates, including those for mortgages, car loans, and other consumer debts. Higher rates can make borrowing more expensive, impacting decisions related to big-ticket items like homes and cars.
As rates go on an upward trend, investors should look at expected increases in expenditure from heightened rates and consider how to budget their cash reserves, or proactively look into short–term cash or money market funds to continue growing their cash.
On an index level, stock and bond markets may react to such events and information like the announcement of economic prints, leading to volatility. While volatility is a common occurrence in the market, it’s important to know that short-term fluctuations in the index and your portfolio should not overshadow the significance of long-term goals.
Given all these potential impacts, how can investors formulate a right investment strategy made for the long haul?
Time in the market, not timing the market
The Fed fund rates play a critical role in shaping US monetary policy, with the most recent mission to tamp down high inflation in the country. Rates also have a broad impact on various aspects, from determining rates offered on savings accounts and the cost of personal and company borrowing.
This begs the question - Should we react every time the Fed fund rates change?
Indeed, it is very tempting to bet on rates and other news flows, but chances are we rarely predict rate movements right. Even if we do, consistently making the right bets based on that prediction is an insurmountable challenge. This adds to the complexity of the market, which arises from the interplay of various factors, such as economic indicators, geopolitical events, company performance, and investor sentiment, to name a few.
Staying invested is key to harnessing the long-term compounding power of investing. By using a dollar-cost averaging (DCA) strategy, investors can ride through cycles and take the emotions out of investing.
How does it work? Let’s say you had invested $500,000 in a broad market index from January 1970 to March 2023, your money would have grown at an annualised rate of around 8% to over $7.7 million.
Remember that the period contains the early 1980s when the Fed funds rate peaked at close to 20% to combat double-digit inflation and also two rate hike cycles following the GFC and the COVID-19 pandemic.
The Endowus Flagship Portfolios are designed to give investors broad exposure to global markets in a strategic and passive asset allocation. This is opposed to a tactical — or short-term and opportunistic — allocation.
You can also choose to DCA your money into these globally diversified, intelligent, low-cost portfolios seamlessly with Endowus.
Click here to get started on Endowus Hong Kong in just a few minutes.
Read more:
- As the Fed starts cutting interest rates
- What is the Federal Open Market Committee (FOMC) and its role in financial markets?
- Facing up to rising mortgage rates
<divider><divider>
Risk Warnings
Investment involves risk. Past performance is not an indicator nor a guarantee of future performance or returns. Projected performance or returns is not guaranteed to materialise. The value of investments and the income from them can go down as well as up, and you may not get the full amount you invested.
Rates of exchange may cause the value of investments to go up or down. Individual stock performance does not represent the return of a fund.
General risk warnings relating to collective investment schemes
Before making an investment decision, you are reminded to refer to the relevant prospectus/ offering document for specific risk considerations and related fees and charges.
Funds are not a bank deposit and not capital guaranteed, and is subject to investment risks, including the possible loss of the principal amount invested.
Some of the funds also involve derivatives. Do not invest in them unless you fully understand and are willing to assume the risks associated with them.
Opinions
Any forward-looking statements, prediction, projection or forecast on the economy, stock market, bond market or economic trends of the markets contained in this material are subject to market influences and contingent upon matters outside the control of Endowus HK Limited (“Endowus”) and therefore may not be realised in the future. Further, any opinion or estimate is made on a general basis and subject to change without notice. In presenting the information above, none of Endowus HK Limited, its affiliates, directors, employees, representatives or agents have given any consideration to, nor have made any investigation of the objective, financial situation or particular need of any user, reader, any specific person or group of persons. Therefore, no representation is made as to the completeness and adequacy of the information to make an informed decision. You should carefully consider (i) whether any investment views and products/ services are appropriate in view of your investment experience, objectives, financial resources and relevant circumstances. You may also wish to seek financial advice through a financial advisor or the Endowus platform and independent legal, accounting, regulatory or tax advice, as appropriate.
No invitation or solicitation
Nothing contained [in this article] should be construed as a solicitation, an offer to buy or sale, or recommendation, to acquire or dispose of any security, commodity, investment or to engage in any other transaction in any jurisdiction in which such solicitation, offer to buy or sale would be unlawful under the securities laws in such jurisdiction. No information included [on this website/ in this article] is to be construed as investment advice or as a recommendation or a representation about the suitability or appropriateness of any advisory product or service; or an offer to buy or sell, or the solicitation of an offer to buy or sell, any security, financial product, or instrument; or to participate in any particular trading strategy. Investors should seek independent financial and tax advice before making any investment decision.
Product Risk Rating: Please note that any product risk rating (the “PRR”) provided by us is an internal rating assigned based on our product risk assessment model, and is for your reference only. The PRR is subject to change from time to time. The PRR does not take into account your individual circumstances, objectives or needs and should not be regarded as advice or recommendation to purchase, hold or sell any fund or make any other investment decisions. Accordingly, you should not solely rely on the PRR in making your investment decision in the relevant Fund.
Complex Products
Some of the funds contained in this article are complex products and investors should exercise caution when investing in these products. Though these products have been authorised by the SFC, authorization does not imply official recommendation. SFC authorization is not a recommendation or endorsement of a product nor does it guarantee the commercial merits of a product or its performance.
This advertisement has not been reviewed by the Securities and Futures Commission or any regulatory authority in Hong Kong.
.png)
