The financial world is buzzing with expectations that interest rates are going to start rising sooner than originally anticipated. But there are some reasons why higher interest rates could be good.
Don’t get me wrong, it could be detrimental in the short-term for some asset values. But, over time, a combination of inflation and business development has led to values climbing over the long-term for many businesses. A short-term decline doesn’t scare me.
As someone with many years of working ahead as well as buying assets (like shares and super), there are three reasons why I think higher interest rates could be a good thing:
Better interest rates from savings accounts
I don’t think it’s a good thing that interest rates are so low. Prior to COVID, money in the bank was barely keeping up with inflation. But in this world of almost zero interest rates and higher inflation, it is damaging to keep money in the bank.
Getting a higher interest rate from money in the bank would more equitably reward savers, particularly people that don’t want any risk.
There are ramifications for people with mortgages or a high level of other forms of debt, but today’s interest rate was always going to be an emergency setting that would change at some point.
Lower prices for growth shares
Higher interest rates theoretically hurt the valuations of growthier businesses more. Some investors like to estimate how they think a business will grow and what profit it could achieve in a few years (such as the year 2025), then they discount that 2025 valuation backwards to today using a discount rate. A key input for the discount rate is the interest rate. The higher the interest rate, the bigger the discount and the lower today’s share price goes, in theory.
Time will tell what this means for businesses like Zip Co Ltd (ASX: Z1P), Temple & Webster Group Ltd (ASX: TPW), Pilbara Minerals Ltd (ASX: PLS), Wisetech Global Ltd (ASX: WTC) and Pro Medicus Ltd (ASX: PME).
I’m always on the lookout for good ASX growth shares. Interest rate changes aren’t likely to affect the revenue growth rate much of those businesses. But being able to buy quality, growing businesses at cheaper prices sounds good to me.
Better yields from dividend shares
The hunt for income yield may unwind somewhat if interest rates are rising. Investors will be able to get a better yield from ‘safer’ investments. This could mean that defensive ASX dividend shares are valued a bit lower, even if the dividend and/or profit keeps rising. For example, the Washington H. Soul Pattinson and Co. Ltd (ASX: SOL) share price has fallen around 17% over just the last month.
Lower share prices means higher dividend yields, assuming the actual dividend payment from the company doesn’t change. A higher dividend yield means that we can get more dividend income from a new $1,000 investment. If an investor has a particular dividend income target in mind (such as $10,000 or $50,000), then higher yields could make it come quicker.
Summary thoughts
I think that higher interest rates would be a good sign – it’s the world returning to a more normal state where emergency financial support is no longer needed. The sooner it happens, the less damaging a potential correction will hopefully be.
I’ve got my eyes open for any opportunities that develop.
