The stock market's performance when interest rates rise

When the inflation rate increases or asset bubbles become a problem, the Federal Reserve raises interest rates to cool down the economy.

Higher interest rates have an impact on the entire economy. Business, mortgage and car loans become more expensive, which slows down cash flow and may cause businesses to pause or amend their growth plans.

Higher rates may also encourage investors to sell their assets and take their profits, which can lower stock prices. If interest rates are high enough, savings instruments like high-yield savings accounts or certificates of deposit (CDs) may also become more attractive to investors.

However, history shows that rising interest rates don't necessarily mean that the stock market will fall. In fact, during the last five interest rate hike cycles, the Dow Jones Industrial Average (DJIA), S&P 500 and Nasdaq either remained stable or showed growth. The only instance where the markets fell during a rate hike cycle was from June 1999 to January 2001.

Experts say that while interest rate hikes can hurt the stock market in the short term, the long-term impact depends on various factors. For instance, rate hikes can benefit certain sectors like financial stocks, but they can hurt growth stocks.

Experts also say that instead of focusing on interest rates, investors should diversify their portfolios by investing in large index funds. This way, investors can already have exposure to short-term winners and can position themselves to be long-term winners.