Interest rates continue to rise in Canada. When the Bank of Canada (BoC) increased its overnight rate to 1.75% in October 2018, it marked the fifth quarter-point increase since July 2017. From a historical perspective, the current rate is considered quite low – the BoC rate was above 4% back in 2008 – but it is up considerably from 0.5% in June 2017.
Whether you’re young or old, a homeowner or a business owner, an employee or an employer, you may be grappling with many questions: What do higher interest rates mean for me? Should I be worried? Do I need to take action?
These are all valid questions, and from a wealth management perspective, it’s important that you take the time to understand how rising interest rates may affect you.
Step one: don’t panic!
When financial markets are shaken up by volatility and changing conditions, as they have been recently, making panic-driven decisions is one of the worst things you can do. A better way to respond? Stay calm and stay focused on your long-term goals.
You may be motivated to act quickly in the hope of shielding your wealth against a market downtrend, but a hasty misstep can cost you dearly. You’re much better off taking a deep breath, speaking with your advisor and keeping your focus on the strategies already in place that are moving you toward your long-term goals.
Seeing the upside of higher interest rates
Of course, there are certainly downsides to higher interest rates. If you have a mortgage, you may be shielded against short-term changes if you have a fixed-rate mortgage; however, sooner or later your monthly payments will likely increase if interest rates continue to rise.
If history is any guide, stock values may also be negatively affected by higher interest rates. Individual stocks can always buck the broader market trend and rise or fall regardless of what other stocks are doing. Overall, however, stock prices tend to soften as interest rates rise as companies face higher borrowing costs and thus become more cautious in the efforts to drive growth.
On the other hand, there are also opportunities that emerge as interest rates climb higher. For example:
- Potential for higher growth of life insurance investments. When interest rates rise, so do bond yields. This is good news for insurance companies, which tend to invest a significant proportion of their funds in fixed-income assets such as bonds. After an extended period of low interest rates in Canada, the recent upward trend of rates means that insurance companies can boost their overall returns by investing in higher-yielding bonds. If you hold a participating life insurance policy, this means the value of the investment component of your policy may see a boost.
- Potential for a stronger Canadian dollar. There are many factors that can influence the value of the Canadian dollar, or any currency for that matter. In general, though, higher interest rates in Canada tend to correspond with a stronger Canadian dollar. Why? Because demand for the currency rises as more people want to take advantage of the rising interest rates here. And as the Canadian dollars you are holding strengthen relative to other currencies, your purchasing power also rises when it comes to investments denominated in those other currencies.
Assess the impact and optimize if needed
From a wealth management perspective, it is crucial to understand the likely impact of higher interest rates on your investments, as well as the tax implications of this.
In Canada, different types of investment income are taxed differently. If you have a high marginal tax rate, your interest income – for example, from bonds or GICs – will likely be taxed at a higher rate than income from capital gains or dividends. To minimize your tax bill, it may make sense to ensure that interest-generating investments are in a registered account such as a registered retirement savings plan (RRSP) or a tax-free savings account (TFSA).
With Canada’s rising interest rates affecting different aspects of your finances in different ways, it’s important to speak with your financial advisor to understand the implications and assess whether you should make any adjustments in your wealth management strategy. If you would like assistance understanding how rising interest rates will impact your finances, contact Rubach Wealth at (647) 349-7070.