Financial Review: Interest you?

How do the rise and fall of our country's interest rates affect you and your portfolio? Even though there are myriad opinions on ‘what the rates will do’ over the next year or so, it is important that you understand what changes in interest rates mean for you.

Over the past year, we have seen the Federal Reserve lower rates to unprecedented levels in an effort to spur the economy. The intention is that lower rates will encourage us as consumers to spend more, borrow more, and therefore lead to greater revenue generation for companies who are selling goods and services. As an investor, there is an additional perspective on rates that is important.

Lower Interest Rates:

For stock investors, falling interest rates are typically good news. With lower rates, companies may borrow more money to expand their business; spurring growth is a certain positive for stock investors. Additionally, with lower rates, companies are able to decrease the cost of debt on their financial statements, which may positively affect their bottom line.

For bond investors, lower rates may be bad or neutral news. Bond investors would be unaffected by lower rates if they are holding their bonds to maturity and continue to receive the stated interest rate on their bonds. However, it could be bad news because, as bonds mature, you may be forced into reinvesting those funds at lower interest rates. Additionally, some bonds are callable, which means the company can call their outstanding bonds and issue new bonds at the new lower rates.

Higher Interest Rates:

For stock investors, increased rates could be a positive or a negative. Typically the Fed raises rates in an effort to slow down an overheating economy, thereby slowing down lending and borrowing. When this occurs, it may mean stock prices drop as a result of higher rates and less growth. Additionally, a jump in interest rates may send jitters through the market causing stock prices to fall. Depending on the economy and market conditions, potential exists for positive returns when rates are increased, especially if you are invested in companies that may benefit from high interest rates.

For bond investors, a rise in interest could have positive and negative effects, as well. Negative effects may result because as higher rates are assigned to new bonds being issued, the trading price of bonds you currently own will decrease; however, if the bond is held to maturity, there would be no change. The positive effects will come if you have maturing bonds and you are able to then reinvest those funds with bonds carrying a higher coupon rate.

Whether rates are on the rise or not in the near future is anyone’s guess. It is important, however, to know how rate fluctuation may affect your portfolio. Stocks offer long-term growth potential, but also carry greater volatility. Bonds offer a fixed rate of return and investment principal if held to maturity. Both stocks and bonds may play an essential role in your investment portfolio no matter the rate conditions.

Mark Zagrocki is a Financial Advisor and Chartered Retirement Planning Counselor with Wells Fargo Advisors, LLC in Westlake. Wells Fargo Advisors did not assist in the preparation of this report, and its accuracy and completeness is not guaranteed. The opinions expressed in this report are those of the author and are not necessarily those of Wells Fargo Advisors or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Wells Fargo Advisors, LLC, Member SIPC.
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Volume 1, Issue 7, Posted 7:24 PM, 11.04.2009