You’d have to have been living under a rock for the past year to not know that interest rates have been on the rise as central banks around the world endeavour to return rates to normal levels, following sharp cuts through the pandemic.
Normalising rates is not without pain, however, as many who bought homes two or three years ago are very well aware right now. But higher interest rates can affect investors too.The most direct way that higher interest rates impact your share portfolio is the effect they have on borrowing costs. Higher interest rates mean that both businesses and individuals must spend more of their available cash servicing debt.
For both businesses and individuals, higher interest rates reduce economic activity. In an environment of reduced economic activity, it’s reasonable to expect most companies listed on the stock market to face challenges in growing their profits.In some cases, profits might decline, and potentially in extreme cases, profits might evaporate entirely. Therefore, higher interest rates impact your share portfolio by reducing the profits of the businesses that you own.
When the cost of money was two or three per cent, borrowing and investing in shares was a pretty easy play. Looking at Australian shares at least, the dividends alone were typically enough to cover the interest expense. But with the rapid rise in interest rates that we’ve seen, that gets tougher.The third way that higher interest rates impact your share portfolio is by providing investors with more alternatives.
As rates rise, that tide is turning. Term deposit rates of 4 per cent plus mean that some investors are backing out of share market investments and returning to the defensive investments that are their preference. Even bonds, which have had a horrendous 18 months, now look to be quite reasonably priced, providing another alternative for those investors seeking greater stability.
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