{"id":16693,"date":"2023-09-18T09:58:21","date_gmt":"2023-09-18T16:58:21","guid":{"rendered":"https:\/\/canary.kcprod.info/blog\/?p=16693"},"modified":"2024-09-16T09:31:36","modified_gmt":"2024-09-16T16:31:36","slug":"invest-when-rates-rise","status":"publish","type":"post","link":"https:\/\/canary.kcprod.info/blog\/invest-when-rates-rise\/","title":{"rendered":"Why Higher Interest Rates Shouldn\u2019t Prevent You From Investing"},"content":{"rendered":"\n

This year, interest rates reached their highest level since 2007 and are expected<\/a> to stay relatively high through 2024. This higher-rate economic environment brings excitement but also confusion. You may be asking, \u201cwith all of the compelling ways to earn more on my savings, are equities worth the risk?\u201d Thankfully, we have decades of data to help us answer this question. And it may surprise you that the analysis shows it would be foolish to forego equities.<\/p>\n\n\n\n

A brief review of interest rate policy<\/strong><\/h2>\n\n\n\n

If you\u2019re one of the many people who came of age during the Great Recession in 2008, rates have been low for as long as you can remember. However, the recent zero-interest rate environment is an anomaly when looking back over the past 50 years. <\/p>\n\n\n\n

From January 1973 through December 2007, interest rates were above 4.00% more than 80% of the time<\/a>! The less prevalent periods when rates dipped below 4.00% occurred following financial instability: after persistent higher inflation from 1992 to 1994 and after the burst of the dot-com bubble from 2001 to 2005. Rates have gone to zero only twice in the past 50 years: 2008 after the Great Recession and 2020 after COVID-19. So, as you can see, we can analyze many previous high interest rate periods to understand how different saving and investing strategies performed historically. <\/p>\n\n\n\n

What history teaches us about investing through different interest rate periods<\/strong><\/h2>\n\n\n\n

While looking backward can\u2019t predict what will happen next, it can shed light on why we believe equities still have a place in a diversified portfolio, regardless of how appealing interest rates might seem. To show this in practice, we analyzed how equities have performed in comparison with bonds and high-yield savings rates throughout a number of time horizons and under several scenarios. Our analysis shows that over the long-term it is better not to give up on equities, regardless of interest rates. <\/p>\n\n\n\n

Our first analysis compares how equities, bonds, and high-yield savings rates have performed over the past 50 years (beginning on June 1, 1973, and ending on May 31, 2023). As shown in the below graph, over a longer time horizon, equities consistently and dramatically outperform bonds, which consistently outperform high-yield savings rates<\/strong>. <\/p>\n\n\n\n

In our analysis, as described throughout this post, we represented equities using the US total market returns series from Ken French\u2019s website<\/a>, which includes both large and small-cap US stocks. We represented bonds using 5-year Treasury returns because of their medium time frame, and we represented the high-yield savings rate using 1-month Treasury returns because it is a commonly accepted measure of the risk-free rate and accurately represents the highest available savings yields. (Note that we continue to use the same data sources to represent each category\u2014equities, bonds, and high-yield savings rates\u2014throughout this post).<\/em><\/p>\n\n\n\n

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Given the key principles of investing, this outcome shouldn\u2019t be surprising. A fundamental principle of investing is that for higher risk you have the potential for more reward in the long run. Since high-yield savings accounts are on the lowest end of the risk spectrum in our analysis, followed by bonds offering a medium amount of risk, and equities offering a higher amount of risk, we would also expect the long-term returns to follow that pattern.  <\/p>\n\n\n\n

How does performance vary between low vs. high-interest rate environments?<\/strong><\/p>\n\n\n\n

Interest rates and bond yields are high right now\u2013does that mean cash and bonds provide a better outcome than stocks? To answer this question, we analyzed how high-yield savings rates, bonds, and equities perform in high versus low-interest rate periods. To do this, any month with an average effective Fed Funds rate higher than 4% over the past 50 years was included in the \u201cHigh-Interest Rate Period,\u201d and any month lower than 4% was included in the \u201cLow-Interest Rate Period.\u201d<\/p>\n\n\n\n

The graphs below show the average annualized return over these High and Low-Interest Rate Periods for stocks, bonds, and high-yield savings in the past 50 years. <\/p>\n\n\n\n

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It\u2019s clear from this analysis that regardless of whether it was a period of low or high interest rates, on average, equity returns were significantly higher than bonds, and bond returns were considerably higher than high-yield savings rates. <\/strong>When saving rates increased, bonds and equities moved higher as well. The margin of return for equities over bonds and bonds over high-yield savings rates remained similar in both high and low-interest rate periods, with equities outperforming bonds by about 4%, and bonds outperforming high-yield savings rates by more than 2%. <\/p>\n\n\n\n

Do higher interest rates mean the end of the 60\/40 portfolio?<\/strong><\/h2>\n\n\n\n

When bond yields increase, there is often an uptick in news headlines predicting the end of the 60\/40 portfolio (60% US stocks\/40% bonds). Instead, some may advocate for a different mix of asset classes, and one formulation in particular that gains appeal when rates are high is the 40\/60 portfolio (40% stocks\/60% bonds). Given the attractiveness of today\u2019s bond yields, would it be better to upweight bonds and decrease stocks when rates increase above 4%? <\/p>\n\n\n\n

To test this theory, we analyzed the performance of a 60\/40 portfolio composed of 60% equities and 40% bonds using the same representative asset classes mentioned above and compared it to a portfolio that upweights those bonds to 60% and down weights those equities to 40% when interest rates go above 4%. To put this analysis in dollar terms, we compared 30-year portfolio return scenarios for investors who we assumed deposited $500 on the last day of each month between May 31, 1993, and May 31, 2023.<\/p>\n\n\n\n

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Our analysis shows that the 60\/40 portfolio comes out ahead even across higher interest rate periods, and investors who chose to upweight bonds would have lost out on nearly $55,000. <\/p>\n\n\n\n

How could foregoing equities impact your wallet?<\/strong><\/h2>\n\n\n\n

The above analysis makes it fairly obvious that long-term investments in US equities outperformed 5-year Treasury bonds even in high interest rate periods. But given how enticing today\u2019s interest rates are, we wanted to map a few scenarios to show in detail how different allocations to equities, bonds, and high-yield savings could impact your wallet over the long-term. <\/p>\n\n\n\n

In our analysis, we again focused on the past 30 years and plotted how much someone who started investing on May 31, 1993, would have on May 31, 2023, if they deposited $500 each month between five scenarios with varied percentages in equities, bonds, and high-yield savings: <\/p>\n\n\n\n