Why are investors concerned about rising interest rates?
One of the key jobs of central banks is to keep inflation under control. However, due to the COVID-related supply disruptions and a shortage of people to take up jobs, the price of many goods and services has shot up – and is well above what is considered to be normal.
Central banks can tackle inflation by raising interest rates. In doing so, they increase the cost of borrowing, and this can discourage investment and dampen household spending – which in turn can lead to a cooling of prices.
This can flow through to company profits, and explains why equity markets can fall when interest rates rise.
In the US, most investment commentators now expect its central bank to raise interest rates four times in 2022.
In fact, this is a sharp about-turn in expectations, as less than 12 months ago, many did not expect to see US interest rates rise until 2023. It’s this change in sentiment that has sent markets lower.
Meanwhile, in New Zealand, the Reserve Bank of New Zealand looks set to continue to steadily raise interest rates this year.
Adding to the current uncertainty in markets is the geopolitical situation in Eastern Europe, amid fears that Russia may be on the verge of invading Ukraine.
Stay the course and focus on the long-term
We know that it’s hard seeing the value of your investments going down. But it’s important to take a step back and remember just how well equity markets have performed of late.
Over the last three years, the S&P 500 Index in the US has delivered annual returns of more than 15%, and in two out of three of those years it saw gains of more than 25%.
This was despite some sizeable falls in equity markets brought about by the COVID-19 pandemic.
While instinct may tell you to switch to a ‘safer’ investment option, having patience is usually the best strategy in unsettling times. In March 2020, when equity markets fell on the back of COVID-19 concerns, we saw a lot of investors switch out of growth-oriented funds into more conservative ones.
However, it meant that many missed out on the rebound in markets that followed.
The moral of the story? Stay the course. It’s hard to predict when markets will change direction, and trying to pick the best times to change funds comes with risk.