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Understanding interest rates

How rates affect investment returns

Investments are influenced by a variety of factors outside your control, such as shifts in a particular market, natural disasters and economic downturns. Another important factor is interest rates. Changes in interest rates affect different types of investments in different ways.

  • Cash. Interest rate rises are good news for the savings in your bank account, as you will receive more interest each month.
  • Fixed interest. If you already hold fixed interest investments such as government or corporate bonds, interest rate cuts are good news. This is because the capital value of a bond rises as interest rates fall. For example, let’s say today you purchase $100 worth of government bonds paying 6% pa interest. If the government issues a new $100 bond tomorrow that only pays 5.5% pa, your bond will increase in value as it pays more interest than the new bond.
  • Direct property. If you are paying off a mortgage on an investment property, an interest rate rise will increase your repayments. The effect of an interest rate change on property values – and your capital gain or loss – is indirect and harder to predict.
  • Shares. Interest rate cuts are usually good news for share prices. Many companies borrow money to fund investment and expansion. If borrowing costs decrease, it is cheaper for companies to access the capital they need, lifting profits. When profits rise, share prices generally rise as well. Lower borrowing costs also encourage businesses to invest in new machinery and equipment to boost future production and improve efficiency. This is good news for profits and share prices.
  • Listed property trusts. Many listed property trusts borrow heavily to acquire the properties they manage. When interest rates rise, it becomes more expensive for listed property trusts to repay their debts. This can depress earnings and share prices, especially because they are often more exposed to debt than others in the share market.

The effect of interest rates on gearing

If you have taken out a loan to fund your investments, such as a margin loan to invest in managed funds or a mortgage to buy direct property, increases in interest rates will increase your loan repayments.

Before you take out a loan, it’s a good idea to check whether you could continue to make repayments if interest rates were to rise.

If you’d like to find out more about the effects of interest rates on investment returns, you can book an appointment online to organise your complimentary, no-obligation consultation with a Commonwealth Financial Planner.

  • Important information
    The information contained on this web page is of a factual nature only and is not intended to constitute financial product advice. It has been prepared by Commonwealth Financial Planning Limited without considering your individual objectives, financial situation or needs. You should consider its appropriateness in light of your circumstances and consider seeking professional advice relevant to your individual needs before making a decision based on this information. Commonwealth Financial Planners are Representatives or Authorised Representatives of Commonwealth Financial Planning Limited ABN 65 003 900 169, AFSL 231139, a wholly owned but non-guaranteed subsidiary of Commonwealth Bank of Australia ABN 48 123 123 124.

    Investment products are subject to investment risk, including the loss of income and capital invested. Past performance is no indication of future performance.
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