When it comes to interest rates, 2016 is looking to be an echo of 2015. If everything holds true, and 2016 is a repeat of last year, the Federal Reserve Board and Federal Reserve Board Chair Janet Yellen will likely raise interest rates at the Dec. 14 meeting.
An interest rate hike isn’t a 100-percent probability; plenty of factors could cause the Fed to decide to hold off until 2017. However, with high expectations that a rate increase could come in the last month of this year, investors might wish to start making changes to their portfolio to prepare — so they’re not taken by surprise if a rate hike does happen.
How to Maximize Your Investing Strategies for the New Interest Rates
Out of the past eight years, last year’s rate hike was the only increase that occurred, so portfolios might be in need of considerable changes. Here are several principles to consider:
1. Keep to the Middle
Investors should consider bonds and include normal allocation to intermediate to longer-term rather than shorter-term bonds. You can expect a flattening yield curve with larger interest-rate adjustments occurring in shorter maturities.
2. Consider Municipals
Historically, municipal bonds have traded more in line with U.S. Treasury bond prices, with a time lag. For long-term investors, this often works well for their portfolios. Municipal bonds don’t usually behave like corporate bonds because they have different income drivers and leverage.
3. Try Equities
Although a rate hike is expected in December, the pace of rate hikes is expected to be slow. It’s safe to guess that inflation and wage gains will be moderate, which could affect sectors and companies that are growing revenue and gaining market share. Currently, nearly half of all companies in the Standard & Poor’s 500 index offer dividend yields greater than the current 10-year Treasury yield. And for many investors, tax rates on dividends are lower than tax rates on bonds, giving equities a nice appeal.
Not all equities are created equal, and not all will respond to a rate increase in the same way. Companies that have a global customer base, specialize in e-commerce, cloud computing and online connectivity could be well-positioned to grow faster than the economy. Health care-related companies that serve the aging population also fit into this category.
4. Don’t Dump High-Yield Bonds Just Yet
Usually, when rates go up, bond prices will fall. But before making any decisions to sell, consider the income on a high-yield bond. As rates rise, this income can help offset falling prices.
5. Don’t Rely on Cash
As far as bank interest rates go, you might earn a quarter of a percent on cash deposits, but you won’t be taking advantage of the best interest rates available. When you put your money into bonds and stocks, it should work harder for you. Also consider if what you’re earning on your cash deposits is keeping pace with the rate of inflation. Having some cash on hand is good for a portfolio, but with the expectation of rates increasing in December, you might want to rethink that amount.
It’s safe to anticipate that the rate increase in December will only be a small, incremental change to the capital market backdrop. Because of this, the changes to your portfolio — as well as mortgage rates and rates on loans — might also be small. Do your research diligently and exercise caution on your decisions. The time you spend reviewing your investments and how they’ll align with your goals is time well spent, and provides you with one of the best opportunities for increasing the potential to achieve long-term success.