Higher rates don't just affect bondholders. Companies that used relatively cheap borrowing costs to expand over the past 10 years have also felt the sting of rising rates. The NASDAQ Composite Index, which mostly represents technology stocks, is down more than 32% in 2022 as interest rates rise.
There have been a few bright spots during the rising rate of the past few years, however, the first of which has been the guaranteed investment certificate (GIC). Beginning in 2022, you can buy one-year GICs paying 1.5% interest. At the end of that year, one-year GICs were paying more than 5% interest. The five-year GIC saw a similar increase in rates, from about 2.5% to 5% by the end of 2022.
Why inflation continues to affect investors
Like the Bank of Canada, other major banks around the world have raised interest rates in an effort to return monetary policy to the low and predictable levels we've become accustomed to over the past 30 years.
Both the Bank of Canada and the US Federal Reserve have said that persistent inflation is more of a threat to the economy and livelihoods than the short-term pain of rising interest rates and a sluggish economy. They wanted to avoid a repeat of the painfully high inflation period of the 1970s at all costs, which is why rates rose as they did and stayed there until the central banks were convinced that inflation had been reduced.
That seems like a reasonable decision, given that stock and bond prices are about future expectations. Predictable inflation allows businesses and consumers to make confident spending and reinvestment plans. Persistent inflation brings uncertainty, leading to volatility in asset prices.
The best-case scenario is a gradual slowdown, where inflation returns to the 2% target without tipping the economy into recession.
What investors can do is protect retirement savings
If you're retired, close to retirement or still several years away but planning your retirement savings, the high inflation scare of the past few years may keep you up at night. How can you reduce your impact on your purchasing power now and in the future?
The best defense is diversification, according to Benjamin Felix and Cameron Passmore, portfolio managers at PWL Capital in Ottawa. In an episode of their investment podcast, Rational Reminder, Felix said investors can reduce the risk of their entire portfolio having zero or negative real returns by holding additional sources of expected returns in their portfolios. That includes value stocks, domestic and international stocks, and fixed income, if it makes sense for the portfolio.
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