Published November 2003

What do rising interest rates mean to investors?

As you likely noticed, long-term interest rates have risen significantly over the past few months. If you’re an investor, what do these higher rates mean for you?

There’s no one simple answer. How you respond to various economic events — such as a higher interest-rate environment — likely will depend on factors like your investment preferences, risk tolerance and financial objectives. Also, in looking ahead, trends in long-term interest rates are notoriously hard to predict. But it’s interesting to note that the Federal Reserve seems committed, in the near term at least, to keeping short-term interest rates low. This stance by the Fed could also help restrain increases in long-term rates.

But let’s take a look at how a change in rates might affect your investments.

Let’s begin with stocks. Rising interest rates are frequently accompanied by a strong economy, which generally translates into greater profits for companies (and potentially higher stock prices).

On the other hand, higher rates mean that companies’ borrowing costs would likely increase. Were that the case, expanding their operations could become more expensive. This added cost could negatively affect stock prices.

In short, it’s impossible to say unequivocally that rising interest rates are always good or bad for stocks. Of course, the best thing to do is hold onto high-quality companies for the long term, regardless of interest-rate changes. This is how you create the opportunity to build your wealth over time.

Now, let’s consider the impact of rising interest rates on bonds. Unlike their effect on stocks, the effect of higher rates on bond prices is clear: When rates go up, bond prices drop. If you have a bond that pays 4 percent — but market rates rise to 6 percent — nobody would want to pay full price for your bond (assuming you wanted to sell it prior to maturity). So, if you wanted to sell the bond before its maturity date, you’d likely have to sell it at a price that is less than what you paid.

Of course, if you plan on holding your bonds until maturity, you might not care about rising interest rates and falling prices. No matter what market rates are doing, you can expect to receive regular, fixed interest payments. And, as long as your bond is of good quality, you can expect to receive the face value back when the bond matures. Additionally, insured bonds can increase the credit quality even more. (Keep in mind, however, that insurance does not eliminate market or interest-rate risk.)

But even if you do hold your bonds until they mature, you can take steps to blunt the impact of rising interest rates. How? By building a “bond ladder’’ — a portfolio of bonds with short, intermediate and longer-term maturities.

In a rising-rate environment, when the short-term bonds in your “ladder” come due, you should be able to reinvest the proceeds in new bonds paying a higher rate. And in the event rates fall, you’d still have your longer-term, higher-yielding bonds working for you.

Eric Cumley is an investment representative with Edward Jones Investments at 1201-C SE Everett Mall Way in Everett. He can be reached at 425-353-2322. Edward Jones is an NYSE-member investment firm with more than 8,000 locations nationwide.

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