Hello, I'm Clare and welcome back to Smart Investor the series that helps you get to grips with investing. In this episode, I'm going to look at what rising interest rates mean for your investments. Although we're frequently told about the impact of higher rates on our savings and mortgages it's often less clear what they might mean for the rest of your finances.
Please be aware that we can't offer personal advice so if you don't feel confidence about making an investment decision on your own do seek independent, financial advice.
Interest rates are closely linked to inflation and if the Bank of England decides to increase rates it's usually to help curb inflation or the rising cost of living. Raising rates makes borrowing more expensive.
This slows down demand for goods because the cost of meeting existing debt repayments or borrowing new money goes up leaving us with less to spend. In turn, this helps reduce inflation. By contrast, when interest rates fall lower costs encourage businesses and households to borrow more, boosting the economy.
The Bank of England has said that interest rate rises are likely to be gradual and limited over the next few years. Rising interest rates are good for savers as they mean higher returns on savings accounts. However, they're often seen as less positive for stock markets. Consumers and businesses tend to spend less on goods and services when the cost of borrowing is higher affecting companies which supply these.
Interest rate rises typically boost the value of sterling too which can prompt share prices in large multi-national companies to fall. That's because many of them earn revenue overseas so when sterling is stronger it reduces their foreign profits when they're converted back into pounds.
When sterling is stronger however it can give smaller companies a boost as it strengthens the buying power of their British customers. Some companies tend to fair better than others when rates are rising. For example, interest rate rises usually signify that an economy is strengthening so financial companies may see an improvement in their margins when their rates go up meaning profits should in theory also rise.
While steeper borrowing costs tend to benefit financials sectors such as technology or producers of non-essential goods tend to perform less well because consumers don't have as much spare cash to spend.
Rising interest rates also impact fixed income investments such as bonds and gilts. Bond prices tend to rise when interest rates go up because the fixed rate of interest they pay becomes more attractive to investors. Conversely, when interest rates fall bond prices typically weaken because the fixed rate of interest they pay becomes less appealing.
It's important to remember interest rates aren't the only factor that can influence market movements. Other factors which can impact markets include what's going on politically, general investor confidence, and economic growth prospects.
As I've just touched on the impact interests rates have on your investments can vary depending on what you invest in. This is one of the reasons why it's a good idea to spread your money and have a diversified portfolio.
Investing across a wide-range of assets such as stocks and shares, bonds, cash, and property means that if one or more of your investment falls in value in response to higher rates others might rise and vice versa, evening out fluctuations.
You should be thinking long term at least five years for all of your investments as there is risk that you could get back less than you originally invest. We have lots more information about investments and how interest rate changes can affect them on our website which should help improve your knowledge and understanding. Thanks for watching and see you again next time.