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What to do when interest rates change

Recent RBA announcements are a reminder for investors to take stock of the risks they are taking, and to stay focused on their long-term goals.

The recently announced 0.5 percentage point rate rises might have come as a surprise to many, after years of ultra-low interest rates. But the RBA announcements – a step to address inflation and the ongoing global energy shock – is a reminder for investors to take stock of the risks they are taking. While it is tempting to conclude that the change in the cash rate will placate the markets and their economic view, we think investors need to stay focused on their long-term objectives.

For most, a change in the cash rate is not sufficient to justify a wholesale change in investment strategy – especially given that markets can overreact, and global economic data could surprise to the downside, relative to expectations, for the rest of the year.

For investors worried about the anticipated continued rise in interest rates would do well to recognise that current prices in the fixed income market have already priced in the possibility of future increases. Further, while it is true that bond prices typically reduce as rates rises, newly issued bonds are also delivering increased yields, thus offsetting the initial reduced returns, if investors continue to reinvest into higher yields.

Things investors can do amidst changing interest rates: Understand how interest rates affect investments

When it comes to investing, interest rates affect different investments in different ways so it’s always best to first understand the basics of how interest rates work.

Tune out the noise

With continued rate hikes on the cards in the not-too-distant future, inevitably there will be a lot of market speculation and commentary.

While staying informed is important, it’s also essential to remember that current headlines report on the here and now. What this means for investors is that these headlines are already priced into the fixed income and equity markets and thus any action taken now may be belated. The downsides of emotionally reacting to market noise and the impact it can have on your long-term financial goals should not be understated (a prime example of this is the effects of cashing out when COVID-19 first struck). 

If you’re still feeling unnerved about what rising interest rates may mean for you, consider consulting a licensed financial adviser who can help guide you through the uncertainty. The value of good financial advice goes beyond just investment returns.

Bonds are still essential

Many myths and misconceptions about investing in bonds abound, particularly during periods of rising rates, often coupled with calls for investors to make drastic portfolio changes. But while it is true that bond returns have taken a hit since the start of this year, any suggestion to avoid bonds today may be backward-looking and probably belated.

Have a budget

While rising interest rates is designed to help curb cost of living pressures, it’s understandable that rising prices is on the minds of many investors. In times like these, creating a budget could prove to be an invaluable source of comfort. Not only can it help keep you on track to achieve your long-term goals, but it can also help reduce any feelings of financial anxiety that comes with spending above your means.

The above material has been reprinted with the permission of Vanguard Investments Australia Ltd

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