Interest rates play a significant role in income investing, because they directly impact the income generated from various income-generating assets.
This article is going to focus on how interest rates affect the different kinds of assets you may be holding in your portfolio or the ones you’re looking into buying.
If you’d also like to know how interest rates affect sectors read this article.
Note
Inflation often impacts interest rates. Central banks may adjust interest rates in response to inflationary pressures. Higher interest rates can be implemented to curb inflation, and lowered when there’s less concern.
This has been particularly importantly recently because the FED has been raising interest rates in response to inflation concerns.
Interest Effects on Different Assets
Fixed-Income Securities
These types of securities have fixed interest rates. So when interest rates rise, newly issued fixed-income securities offer higher yields, making them more attractive to investors.
This causes existing fixed-income securities with lower interest rates to decline in value since their yields become less competitive compared to new issues.
And when interest rates fall, existing fixed-income securities with higher interest rates become more valuable as their yields become more attractive.
Dividend Stocks
When interest rates rise, income-seeking investors may shift their focus from dividend stocks to fixed-income securities with higher yields. This demand shift may cause certain dividend stocks to underperform.
Conversely, when interest rates fall, dividend stocks may become more attractive as investors seek higher returns than those available in low-yield fixed-income investments.
Real Estate
Interest rate changes have a big effect on real estate investments.
Rising interest rates can lead to higher mortgage rates, which may reduce demand for real estate purchases, potentially impacting rental income and property values.
On the other hand, falling interest rates can make real estate financing more affordable, potentially increasing property demand and values.
As an investor, high interest rates make for an unfavorable acquisition environment because it diectly affects your ROI and profits. Low interest rates are better, but there’s more competition in the market.
Real Estate Investment Trusts or REITs
Higher interest rates can increase borrowing costs for REITs, impacting their profitability and distribution capabilities. This can affect the dividend payments that you receive.
On the other hand, falling interest rates can reduce borrowing costs and potentially boost REITs’ earnings and dividends.
Savings Accounts and Money Market Funds
Interest rates directly affect the income earned from savings accounts and money market funds. When interest rates rise, the yield on these cash-like investments increases, providing higher income to investors.
Conversely, falling interest rates lead to lower yields on these investments, resulting in reduced income.
To Sum Things Up
Income investors need to consider the prevailing interest rate environment when constructing their portfolios.
They may adjust their asset allocation, investment choices, and risk tolerance based on their expectations of interest rate movements or as things change.
Keeping a close eye on interest rate trends and their potential impact on income-generating assets is essential for income investors to make informed decisions and optimize their income streams.
