As experienced over the past two years, interest rate movements can be very sudden. The Reserve Bank of Australia (RBA) increased the cash rate 13 times from May 2022 to November 2023, taking it from a record low of 0.10 per cent to the current rate of 4.35 per cent. Now, with inflation falling globally, it looks like interest rates may have peaked and markets are pricing in cuts in official interest rates by the year’s end.

Predicting short-term interest rate movements is difficult. What is more important is where interest rates will settle over the longer-term. Most assets are priced against the US 10-year government bond yield, which has risen from 1.7 per cent in early 2022 to now being at around 4 per cent. This indicates that rates are close to peaking and could settle around current levels over the longer-term.

In this environment, many investors are wondering how they should position their portfolios. The last decade was a period of record low interest rates and, as a result, many investors moved up the risk curve and allocated more to growth assets such as shares to achieve greater returns. Many ‘balanced’ portfolios drifted closer to an 80/20 shares-to-bonds allocation, away from the traditional 60/40 allocation.

Now, with US and Australian share markets having hit record levels, investors may want to reconsider their overall asset allocation and move back toward the traditional 60/40 mix. That rebalancing could involve taking profits on shares and redeploying cash into more defensive fixed interest investments. For example, longer dated secure fixed interest assets are now providing more attractive yields for investors, with some achieving a 5 per cent-plus yield.

Having said that, investors shouldn’t make significant changes to their portfolios in response to market movements. A more sensible approach would be to tweak portfolios with a gradual increase in exposure to asset classes that are more attractive in a higher interest rate environment. This could include higher-yielding government and corporate bonds and even cash investments as higher interest rates become the new normal.

But first and foremost, keep in mind your investment goals and financial plan and consider how your portfolio can be best positioned to meet your targets in this new environment of higher interest rates for longer.

This article was first published in the Autumn 2024 issue of Financial Times.