Stocks or Bonds:
What Happens When Rates Rise?
Understanding income-producing investments—and how they might behave as interest rates rise—can help guide your search for income
ALTHOUGH THERE ARE NO SPECIFIC RULES about how bonds and dividend-paying stocks respond to rising interest rates, there are some broad tendencies you may want to consider, suggests Mary Ann Bartels, head of Financial Power Wealth Management Portfolio Strategy.
With bonds, the "coupon rate" is the interest rate that an issuer uses to calculate regular interest payments to investors. The longer the term of a bond, the higher the coupon is likely to be; you're paid more to wait longer to get your principal back. Higher risk, too, affects the coupon, with high-yield bonds from less solid companies offering more generous interest payments than you'll get from higher-rated corporations or from U.S. Treasury bonds.
While coupon rates don't change during the life of a bond, bond prices themselves do fluctuate as bonds are bought and sold on secondary markets. And changes in prevailing interest rates will affect the value of bonds in your portfolio. If rates are on the rise, newly issued bonds with higher rates will be more appealing than older bonds paying less. That can reduce demand for your existing bonds and push down their resale prices. When rates are rising, bonds with longer maturities tend to suffer most because they lock investors into lower rates for extended periods.
Meanwhile, dividend stocks are less directly affected when interest rates rise, which has historically happened when the economy is growing. But the kinds of companies that thrive during an economic expansion are also the ones most likely to increase their dividends.
There isn't a single strategy that will work for everyone. "It's important to consider the risks and potential rewards of a variety of assets and take an approach that emphasizes total return," notes Bartels
ALTHOUGH THERE ARE NO SPECIFIC RULES about how bonds and dividend-paying stocks respond to rising interest rates, there are some broad tendencies you may want to consider, suggests Mary Ann Bartels, head of Financial Power Wealth Management Portfolio Strategy.
With bonds, the "coupon rate" is the interest rate that an issuer uses to calculate regular interest payments to investors. The longer the term of a bond, the higher the coupon is likely to be; you're paid more to wait longer to get your principal back. Higher risk, too, affects the coupon, with high-yield bonds from less solid companies offering more generous interest payments than you'll get from higher-rated corporations or from U.S. Treasury bonds.
While coupon rates don't change during the life of a bond, bond prices themselves do fluctuate as bonds are bought and sold on secondary markets. And changes in prevailing interest rates will affect the value of bonds in your portfolio. If rates are on the rise, newly issued bonds with higher rates will be more appealing than older bonds paying less. That can reduce demand for your existing bonds and push down their resale prices. When rates are rising, bonds with longer maturities tend to suffer most because they lock investors into lower rates for extended periods.
Meanwhile, dividend stocks are less directly affected when interest rates rise, which has historically happened when the economy is growing. But the kinds of companies that thrive during an economic expansion are also the ones most likely to increase their dividends.
There isn't a single strategy that will work for everyone. "It's important to consider the risks and potential rewards of a variety of assets and take an approach that emphasizes total return," notes Bartels
