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How Interest Rates Affect Bonds and Stocks

If investors think they’ll be paid 5% interest next year but bonds right now only pay 2% interest, they’ll sell bonds today and wait until next year to buy new ones. As a result, bonds that are currently in the market go down in price when interest rates look like they’re going up. Higher interest rates make it more expensive for people and companies to borrow money (which they then spend on things), slowing down economic growth. But this negative effect can be offset by an economy that grows strongly despite rising rates. Another consideration is that higher interest rates make new bonds appear a relatively more attractive investment compared to stocks. If investors can get paid 5% per year for owning a relatively safe government bond, they might choose to do that rather than choosing to own a stock – the value of which could fall, and has no guarantee of a return. So investors, on the whole, tend to shift some money away from stocks (after the bonds have sold off in price). An environment in which interest rates are going up is not necessarily a bad one for stocks – it just can make things a little more difficult for some.

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