As announced last Tuesday, The Bank of Canada had increased its interest rate by .25%. While this is not catastrophic (it’s even good news to finally signal the exit from this recession!), the rise in interest rates also comes with the fear of having inflation take over. As an investor, how do interest rates and inflation affect your investments?
Well while inflation will negate (or neccessitate) part of your yield (we have no control over it!), the increase in interest rates will negatively affect the market value of your bonds and will also influence your other asset classes.
Stock market: always a winner
When there is an increase in interest rates, this is usually a good sign for the stock market. At first, nobody on the Street (Bay or Wall Street for that matter) will be happy to see the interest rates on the rise. In fact, the markets will probably react negatively on speculation about a change in interest rates. However, if the rate go up, this means that the economy is doing well. Therefore, companies will show improved results and this is when the stock markets will star as the darlings at the dance.
As stocks grow faster than inflation, having a good portion of your money invested in the market remains the right thing to do.
Gold… not good..
As gold is known to be the perfect place for investors when they are afraid of the market, this is probably one of the worst places to invest your money when the investors regain confidence in the markets.
Historical stats show 2 things about gold:
#1 It demonsrates high volatility
#2 It doesn’t outperform inflation
This is why I am not a big fan of gold. I would rather buy gold mining companies or have a resources mutual fund (or ETF) that regroups companies working in the gold industry than buying the metal directly.
Money Market: get rid of it!
If there are people still parked in the money markets, they are really missing a great story. For those waiting for the big comeback of high short-term interest rates hear this: it’s not on the radar for at least another year. Therefore, the worst place to stash your money is definitely in the money market! When you think that ING is giving 1.2% right now… it doesn’t even cover inflation (and I am not even talk about after tax yield!).
Bonds; real rate interest bonds are the solution
If you want to stay in a secure investment area, I suggest you use your track investment apps to find real rate interest bonds. You can also use the investment services from your bank to establish a bond ladder so you will be covered against interest rate increases.
The problem if you don’t have a bond ladder is that you will always be tempted to play the interest rate markets. Trying to determine when it is the “right time” to invest and freeze all your money into a “good” rate. Don’t be a rate rat; invest intelligently.
And if you really don’t want to bother about interest rates and inflation, just go with real rate interest bonds that will track inflation. By keeping them to maturity, you will also avoid losing value due to an interest rate increase 😉
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