Interest rates are not an exciting field of study. Regardless of their entertainment value, it is in your own best interest to understand what interest rates are and how they affect your investments. The term interest rate is defined as the rate that is paid on borrowed money. This rate is applied to the principle of a loan and is usually calculated annually. If the interest rate on your $1000 dollar loan is 10%, at the end of year one the bank will charge you $100 dollars. Interest rates fluctuate all the time therefore they are constantly affecting how companies are growing and there by influence the price of stocks.
Changes in interest rates influence the value of a companies stocks and shares. This is because the risk of a particular investment increases as interest rates increase. As risk increases the cost of stocks fall, and investors lose money. However, the converse is actually beneficial. If the U.S. Reserve decides that the interest rate will be reduced, then stock prices increase, and an investor makes more money.
An increase in interest rates will increase the cost of capital. A company, under a higher interest rate, will have to work harder to create increased returns. If a company fails to generate more return, the interest rate will take a chunk out of their profits. As interest rates increase, profits decrease and this causes the stock value to become reduced and the investor loses money. It is important to keep in mind that companies also have debts. An increase in an interest rate means their monthly obligations go up in price. If they can not afford the increase, their viability is in danger.
An increase in interest rates is usually a good indicator of a slowing economy. The higher interest rate deters people from purchasing things and it stops companies from investing in stock options that will help them grow. This causes sales, profits, and stock prices to fall. The role of interest rates in investing is complicated and can be hard to understand. In general, increasing interest rates are bad for investors because it is bad for the companies they are investing in. Educating yourself about interest rates is important because if you can anticipate a rise in the interest rate you can adjust your financial plan and investment portfolio to compensate for these increased rates.
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