The steep rise in interest rates has been bad for stocks, bonds, and most other investments. The question we all face now is how to invest and save in a higher-rate world. Many people may be tempted to change their financial plan. But if you own a truly diversified mix of investments, the best response for most people is to stay the course.
Below is a brief overview of how rates have impacted investments this year and – more importantly – how they may impact your financial plan in the future.
What should you do with your bonds?
Higher interest rates cause bonds to lose value because you are stuck owning something that now pays a below-market interest rate. The US bond market is down 15% in 2022 – the worst performance in decades. What can you do now?
Today, bonds and bond funds are paying a higher yield than they have for years. For most investors, the right action is to continue owning bonds. If you liked a 10-year US government bond when it paid 1%, as it did in 2021, shouldn’t you love it now that it pays 4%?
What should you do with your stocks?
Higher interest rates have hit stocks even harder. The US stock market is off 25% this year. That’s because of worries that we may be in or near a recession, which higher rates often cause. Stocks are also reacting to inflation, which triggered the rate increases.
What do you do now?
Here are the two most important facts to understand about stock market investing.
- Over the long term, stocks almost always rise as companies grow and create value. That has been true for the last 100 years.
- It’s hard to time when to buy or sell stocks. Every moment of every day, investors collectively put a price on every stock, taking into account everything they know or believe about the future. Are you worried that a recession may push stocks down? If so, it’s almost certain the collective market has thought of that and priced it in.
Our conclusion. Continue to invest for the long term.
What should you do with your cash?
For the past nine months, cash was the best place to keep your money. It was the only major investment class that did not lose value as interest rates rose. But now, bonds pay a lot more than cash. That was not true a year ago. Over the long term, cash has rarely kept up with inflation. Our general advice remains to have enough cash for 1-2 years of expenses, at most.
What should you do with your real estate investments?
Over the last several years, real estate investors saw values surge. Understandably, clients ask if they should increase their real estate holdings. With higher interest rates, mortgages (for individual buyers), and commercial real estate loans (for institutional investors), purchasing real estate now is far more expensive. Future returns are likely to be lower.
In summary, what should you do with higher interest rates?
If you own a diversified mix of stocks, bonds, and other investment classes, the best action is likely to not make sudden changes. Yes, the world is different than it seemed 12 months ago. But, really, it’s not that different. Your financial plan should guide you on how much risk to take – that is, how much of your investments should be in stock or similar investments that can fluctuate significantly. Your plan should tell you how much safety you need – that is, what to put into bonds or cash. Your financial plan probably has not changed a lot over the last year. Your investment strategy shouldn’t either.