How can changing interest rates impact you?

You may hear the term interest rate being thrown around, but what exactly are interest rates?

To understand interest rates, you must first understand what interest is.

Interest is the price paid to borrow money or the cost charged to lend money. Interest is most often calculated as an annual percentage of the amount of a loan, which is called an interest rate. 

Interest rates are used with many types of loans, such as personal loans, mortgages, loans to banks called certificates of deposit (CD) and even loans to the government, treasury bonds. Interest rates are generally set by the market supply of money to lend and the demand for that money. For instance, if there is a high supply of money available to lend, interest rates may be lower. Conversely, if there is a low supply of money available to lend, interest rates may be higher. Further, the ability of an individual or entity to repay their debts may also impact the interest rate of a loan. If the individual or entity has greater ability to repay a loan the interest rate may be lower and if they have less ability to repay a loan the interest rate may be higher.

Although interest rates are dependent on the supply and demand of money in an economy, central (national) banks around the world normally manage short-term interest rates to ensure their economies and credit (loan) markets continue to function properly. In the U.S., the Federal Open Market Committee (FOMC) is the central bank that manages short-term market interest rates. The FOMC primarily focuses on the strength of the economy when determining short-term interest rates. Interest rates can be lowered to strengthen the economy when it is too weak and raised to reign in the economy when it’s too strong, also known as experiencing a period of high inflation. When interest rates are low, people are encouraged to borrow more and save less, and when interest rates are high, people are encouraged to borrow less and save more.

Interest rates can have a significant impact on your investment portfolio. Bond values and interest rates have an inverse relationship, so when interest rates increase, bonds will generally decline in value. However, when interest rates decrease, bond prices will generally increase in value. Bonds with higher yields can be beneficial to investors as they provide a higher return.  

Stocks may also decrease in an environment of rising interest rates as investors become attracted to the higher yields of bonds. Further, higher interest rates may result in companies’ bottom lines being negatively impacted and slow down business activity, causing lower stock prices. These individual stock price declines may result in broader stock market declines and lead investors to make untimely investment decisions.

Certain insurance products may be helpful when navigating periods of rising interest rates. Registered Index-Linked Annuities (RILAs) are annuities that track the stock market to determine gains or losses.¹ RILA returns can be linked to the performance of designated stock market indices while providing partial protection to limit downside risk.¹ While clients can benefit from RILAs by limiting a portion of their investment risk, their upside gains are also capped at a pre-determined limit. During times of uncertainty, RILAs provide the opportunity to participate in stock market gains without taking on the full downside risk associated with typical stock market investing.¹

Fixed-Index Annuities (FIAs) are similar to RILAs as they benefit from market gains but provide even greater downside protection.² With FIAs, your principal is protected even in down markets, and offers guaranteed retirement income for life while mitigating market risk.² During times of rising interest rates and market volatility, having a solution with guaranteed income may be beneficial and ease concerns caused by market volatility.  

Interest rates have been a source of concern for investors of late. In 2022 and 2023, the FOMC raised interest rates several times, reaching a high of 5.5%.³ For the FOMC to consider lowering rates, inflation must continue to show signs that it is recovering to normal levels. Market fluctuations that occur during interest rate cycles can reveal the benefits of having a balanced portfolio. A balanced portfolio with proper diversification may help investors weather periods of changing interest rates.

If you are concerned about the impact of rising interest rates on your portfolio, it may be helpful to speak to your financial professional about how your portfolio is diversified to better navigate changing interest rate environments.