Low interest rates, increased consumer demand, tightening of supply and increase in the quantity of money in circulation: all of these factors explain why in 2022, several increases in key rates are not only expected , but desired, since the current level of inflation appears unsustainable.
How should savers prepare for rising interest rates?
Caution and planning
You should first take time at the start of the year to plan your expenses for 2022, and even those of the next few years. By analyzing your fixed expenses (housing, transportation, groceries) for the past twelve months, you will certainly notice an increase in your cost of living. Ideally, you should reduce your discretionary expenses (personal care, travel, leisure), for an amount at least equivalent to this personal inflation. Failure to adapt in this way would result in a decrease in your ability to save and your emergency fund—and possibly even a slide into debt—unless, of course, your income is up.
If you bought a house in 2021 during the real estate boom at a higher price than expected and at a very low mortgage rate, you should avoid putting your head in the sand. With consumer prices on the rise, you should make the necessary changes to your budget to make room for savings for the next few years: you want a healthy financial situation at the time of mortgage renewal with higher borrowing rates .
The challenge for retirees…
It is rather difficult to take advantage of rising interest rates, as bond yields fall with it. Retirees generally have a good portion of fixed income in their portfolio to ensure their security, as do investors with a conservative or moderate profile otherwise. Already last year, government and corporate bonds have generally shown negative returns—which is very rare—and rising rates point to very low returns for 2022. So the more you hold fixed income in your portfolio, the less growth your portfolio currently allows you to support inflation. In this sense, it is true that retirees are likely to be doubly affected, since they are already in withdrawal.
A diversified approach to fixed income is therefore absolutely necessary to mitigate interest rate risks, for example the use of high yield corporate bonds or emerging market debt securities. Preferred shares are an asset class that generally performs well when rates rise.
If you have a very conservative profile, be careful not to buy guaranteed investment certificates and other fixed income products with too long a maturity. You will probably benefit from renewing them at a better rate in the next few years.
The use of actively managed funds promotes diversification and better selection of securities: you will have easier access to international markets, without currency risk in many products that hedge them. Finally, for moderate-balanced-growth profiles, maintaining a slight temporary overexposure to equity markets could be an option worth analyzing.
Lower your expectations
The years 2020 and 2021, despite all the pandemic backdrop, may have given the impression that growth, returns and government aid are part of the “new normal”. As an investor, you need to approach 2022 with realism as it is a year full of uncertainties. Moreover, the period of economic return to normal will take place in a context of market volatility and lower returns.
Historically, rising inflation has generally been accompanied by a decline in stock market valuations, but unevenly. Thus, US equities are the most likely to see a contraction in their valuation. We must therefore expect average returns for this category and bet on good international diversification of the portfolio. If you are using actively managed funds, expect funds with a “value” approach to perform better.
Emotion is not the ally of investors. Remember that the assumptions used in financial planning take into account these periods of lower growth. We simply have to mourn the returns of the last decade and prepare for them without panicking.