With the Federal Reserve raising interest rates for the first time since 2018, many investors are wondering how this will affect their portfolios. While higher rates can mean higher borrowing costs and increased volatility in the stock market, they can also lead to higher returns on certain investments.
Here’s what investors need to know about rising interest rates.
Increased Volatility In The Stock Market
Rising interest rates can lead to increased volatility in the stock market. This is because when rates rise, it becomes more expensive for companies to borrow money. As a result, stock prices may fall as investors worry about the impact of higher rates on corporate profits.
This held true in the recent interest rate hike, with the Nasdaq 100 entering correction territory. Previously, low rates, and thus low bond yields, drove investors into riskier assets, which helped contribute to the outperformance of the S&P 500 in 2020 and 2021. This time around though, with rates on the rise, we’re seeing investors move out of stocks.
Some Sectors Benefit From Rate Hikes
While rising interest rates can be bad news for the stock market overall, there are some sectors that actually benefit from higher rates.
For example, banks and other financial institutions tend to do well when rates rise because they can charge higher interest rates on loans. This includes the likes of banks, brokers, and insurance stocks.
Further, as a rising interest rate environment is associated with a strong economy, certain sectors like industrials and consumer discretionary stocks may also outperform. This is because improved employment and a healthier housing market lead to greater spending on big-ticket items.
Blue-chip investors looking for higher returns may also benefit from rising interest rates. For instance, short-term and medium-term bonds are less sensitive to rate increases.
A Hit to Venture Capital?
2021 was an unprecedented year for private markets, with record-breaking inflows into venture capital. This was in part due to the low interest rate environment, as investors were seeking higher returns than they could get in the stock market or in bonds.
Now that rates are on the rise, we may see venture capitalists start to pull back on their investments. This could lead to a slowdown in the growth of private companies and a drop in the valuations of venture-backed companies.
That said, the impact likely wouldn’t be too severe. For instance, research from the European Financial Management Association showed that a 1% increase in interest rates “reduced venture capital fundraising by $647 million the following year—or about 3.2%.” While this doesn’t include the longer-term effects of higher rates, it does show that the impact of rising rates on venture capital isn’t as acute as some may think.
What Investors Should Do
Given the potential impact of rising interest rates on investments, it’s important for investors to review their portfolios and make sure they are properly diversified. This means having a mix of investments that will perform well in different market conditions.
While there’s no guarantee that anything will outperform in a rising rate environment, by diversifying your portfolio and having a long-term investment plan, you’ll be in a better position to weather any market changes.
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