Rounding it up
Interest rates are one tool the Bank of Canada uses to influence monetary policy; it does this by raising or lowering the Policy Interest Rate.
Interest rates, whether they’re high or low, impact how all Canadians spend and save.
To protect yourself from rising rates, lock in low rates now, take a good look at your investment portfolio, and start saving more.
Whispers about rising interest rates have been everywhere, not just recently, but over the course of the last year. As the economy began to recover from the pandemic and the first signs of inflation began to show, the question was raised: What will the Bank of Canada do next?
Interest rates are one of the central bank’s biggest weapons to wield in order to influence the economy. When the economy needs encouragement, they lower interest rates. And when the economy needs a little tampering, they raise interest rates. These moves aren’t all good or all bad; they have benefits and they have consequences.
Here, we will cover both the good and the bad of rising interest rates. What you need to know, though, is how to protect your personal finances from the threats that rising interest rates can cause. Don’t worry, we’ll cover that too.
Where Are Interest Rates Headed?
The Bank Of Canada carries out monetary policy by influencing short-term interest rates. It does this by adjusting the target for the overnight rate, called the Policy Interest Rate, on eight fixed dates each year. For several months following the start of the pandemic, this rate had been held steady at .25%. Most recently, though, the Bank has been raising the rate. It adjusted its rate to 3.75% at its last announcement on October 26, 2022.
Now the overnight rate is not the interest rate you as an everyday borrower pay. This is the interest rate that banks charge each other for borrowed funds. When the Bank of Canada raises the overnight rate, however, banks have to pay more to borrow, so they charge their customers more to borrow. This is why you can expect the interest rate you see on paper, such as on a mortgage agreement or credit card statement, to rise in the near future, if it hasn’t already,
How Rising Interest Rates Affect You
So, how do these rising rates affect you? On a basic level, taking on debt will be more expensive. On an economic level, there will be less money circulating, less investment, and less growth. Let’s explore these effects.
Debt Will be More Expensive
If you’ve already locked in a low interest rate on a 5-year mortgage, you always pay off your credit card in full, and you don’t need a new car for at least a few years, you don’t really have to worry about expensive debt at the moment.
However, this isn’t the case for a lot of people. Many people rely on mortgage loans, auto loans, student loans, or personal loans to fund their financial goals. When interest rates are low, it’s easier for people to purchase homes, cars, and boats, and afford further education and other ambitions because it’s less expensive.
Let’s take an example. If you purchase a $50,000 car with a loan with a 5% interest rate, you’ll pay approximately $2,500 in interest over the life of the loan. Now, say that the interest rate increases to 10%. You would then pay $5,000 in interest over the life of the loan. For more expensive assets, higher interest rates increase costs exponentially.
This leads people to borrow and buy less.
Saving Becomes More Attractive
On the flip side, rising interest rates make saving money more attractive. This is because you may have only been able to get .5% (if you were lucky) on your savings when interest rates were low, but now, you may be able to get double or even triple that if you use a high-yield savings account.
While this concept has been pretty foreign over the past few years, it is possible that your savings can grow when interest rates are high.
When interest rates are low, there isn’t much incentive to save. After all, if you can’t earn much of a return on your money by keeping it in the bank, and debt hardly costs you anything, you may as well spend it, especially if you can earn a return by investing it in real estate or the stock market. When interest rates are high, this whole scenario flip-flops.
This leads people to spend less and save more.
The Economy Will Slow
When interest rates rise it becomes more difficult to borrow money for consumers, yes, but also for businesses.
Businesses also take out loans to fund new ventures, equipment, hires, and more. When they can get loans at low interest rates, the risk of being able to pay them back is much lower than if they get loans at high interest rates. So, they take out fewer loans.
Less money to fund new ventures, equipment, hires, and more, means less growth. Less growth means lower valuations, which makes investors less likely to invest. When investors are less likely to invest, stock prices fall.
Additionally, if people are buying less and saving more, businesses don’t experience the same level of sales, and thus profits, as they do when interest rates are low and spending is rampant. So again, valuation decreases and stock prices fall.
If you followed, you learned that rising interest rates lead to falling stock prices.
Yep. That affects you too. For one, your investments will likely lose value, which means your portfolio, and perhaps your precious retirement nest egg, will shrink. Even if you aren’t invested in the stock market (what’s stopping you?), falling stock prices put a strain on the economy. Should prices fall low enough, the country could enter a recession.
Do we have your attention now?
How To Protect Yourself
Borrowing money will become more expensive and stock prices will likely dip somewhat, if not considerably, but high interest rates don’t have to be all bad news. Here are a few ways you can protect yourselves from the pitfalls of rising rates.
Secure Fixed-Rate Loans Before Rates Rise
If you have a variable rate mortgage, now is the time to act. If interest rates rise, so will the interest rate on your mortgage, which could make your monthly payments considerably more expensive and mean you pay much more in interest over time. Talk to your lender about renegotiating your mortgage contract to include a fixed rate that wont fluctuate with rising rates nationwide.
Reallocate Your Portfolio
Many people have a “set it and forget it” mentality with their investment portfolio. Typically, this serves people well as trying to time the market can do more harm than good and, over time, it tends to trend upward.
However, when we know that interest rates are rising and that some investments do better than others during times of higher rates, it’s smart to consider reallocating your portfolio.
Bonds, in particular, are one investment vehicle that perform better when interest rates are high than when they are low. Meanwhile, stocks, as we mentioned above, tend to perform better when interest rates are low.
That said, now may be a good time to reconsider your 70%/30% stocks-to-bonds portfolio to be a little heavier on the bond side.
This isn’t to say that stocks won’t still produce a return. There are certainly companies whose stock prices will rise. To find these unicorns, consider looking at companies that have previously grown during recessionary times and those industries that are well positioned to succeed even if Canadians are spending less.
It may make sense to invest in these industries, rather than funds that track market-wide indexes like the S&P/TRX when interest rates are rising.
As we mentioned earlier, rising rates aren’t all that bad if you know how to handle them. One way they can benefit you is by growing your savings. If you’re worried about where the economy is headed and if rising rates will hurt your portfolio, there’s no better time to save. But don’t just stash your money in any savings account. Compare rates at various banks to find a competitive rate that will give you the best return on your money.
The Future Can Still Be Bright
Secure that fixed rate, reallocate your investment portfolio, and save more. If you take these steps to protect your finances from rising interest rates, you won’t have anything to worry about as the policy rate inches higher and higher.
Ally Streelman is a storyteller whose work spans money, wellness, travel, and more with the chief goal of empowering readers. When she’s not stringing together sentences, you can find her immersed in a new city, cookbook, or novel or encouraging women to take hold of their financial journey.