Invest correctly in times of rising interest rates – this is how it works

• Tightening monetary policy should curb inflation
• High inflation eats away at rising interest rates
• Equities remain attractive

After years of ultra-loose monetary policy, escalating inflation is forcing international central banks to raise interest rates quickly and significantly. Because the effects of the Ukraine war and strong demand and global supply chain problems after the Corona crisis have ensured that inflation rates are far from the goal of the monetary authorities – the ECB, for example, is aiming for an inflation rate of close to two percent. Higher interest rates are now intended to dampen aggregate demand and thereby slow down the rise in the price level.

Tech stocks are suffering

These interest rate hikes weighed heavily on the stock markets, which saw significant falls over the past year. The technology sector, which has been the engine of the bull market in recent years, is particularly hard hit. The fact that growth stocks fell under the wheels in such a way was partly due to the fact that tech companies are usually more heavily leveraged, so rising interest rates also mean significantly higher financing costs for them. In addition, companies are often reluctant to invest in new technologies or software in times of higher interest rates.

Value stocks in demand

Many investors are shifting their portfolios and are increasingly investing in value stocks, i.e. companies that are growing more slowly but are characterized by a solid business model, a dominant market position and low debt. Of particular interest are so-called defensive quality stocks – these are corporations whose demand for their products is little affected by the economic cycle. An example would be manufacturers of consumer goods such as detergents or toilet paper. Another advantage is that quality stocks usually pay dividends relatively reliably. But even with such stocks, price losses are of course possible, so that investors may need stamina to sit out a dry spell with many losses.

bonds

The bond markets are also in flux. Times are not rosy for existing bondholders. On the one hand, the central banks are curbing their purchases of securities, which means that their artificial demand is gradually disappearing. On the other hand, old bonds are devalued by rising interest rates because newly issued bonds bear higher interest rates. Investors are therefore switching to the new debt securities, which leads to price losses for the old ones.

In the case of newly issued bonds, on the other hand, investors can look forward to a higher coupon rate. In addition, bonds are relatively safe compared to stocks. But here, too, interest is likely to be limited if market participants expect interest rates to rise further in the coming months. Investors should also note that given the high level of inflation, the real interest rate on many bonds – which takes into account the development of purchasing power – remains negative.

Inflation eats up savings

In principle, rising interest rates for savings deposits are positive. The days of penalty interest are coming to an end and instead, competition between banks in their interest rate offerings is picking up speed.

That would actually be good news if very high inflation weren’t rampantly eroding the value of savings. Since the inflation rate is higher than the nominal rate of return, wealth loses purchasing power. Anyone who still relies on a savings account – for example because the stock market seems too uncertain – should do so with a fixed-term deposit with a shorter term in order to remain flexible. This has the advantage that, should interest rates rise further, the investor is not stuck in a long-term investment with weak interest rates. Call money accounts are more flexible than fixed deposits. You can get the money at any time, but the interest rates are very low.

Gold for portfolio addition

While gold is considered a safe haven and a good hedge against inflation, it could suffer from tighter monetary policy. Since the yellow precious metal does not yield any interest, interest-bearing forms of investment are becoming more attractive in relative terms. However, adding gold to a portfolio can still make sense for risk diversification. A well thought-out diversification of assets is extremely important, especially in uncertain times. As a rule of thumb, many consultants recommend a share of between five and ten percent.

Uncertainty in the crypto sector

There is simply no experience of how cryptocurrencies will develop in times of rising interest rates. Since the introduction of the original cryptocurrency Bitcoin, interest rates in the euro area have basically only gone down and in the USA there has only been one cycle of increases since then – from the end of 2015 to 2019. However, it is difficult to assess the impact of these interest rate hikes on the crypto sector After all, cyber currencies were still in their infancy at the time.

Recently, however, it has been observed that cryptocurrencies tend to follow the stock markets. This could be because they are considered a risky asset by investors. These are usually burdened by rising interest rates because, in contrast to low-risk forms of investment such as savings deposits, they do not generate any interest income.

Conclusion

Investors don’t have it easy at the moment. Those who shy away from risk have to watch as their savings lose significantly in value due to inflation. On the other hand, anyone who ventures into the stock market can hope to beat inflation. Here you should pay attention to a broadly diversified investment, but even then there is a risk of severe price losses, so that staying power may be required.

Editorial office finanzen.net

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