How to Prepare Yourself for Higher Interest Rates Post-COVID
Rising inflation concerns and statements from U.S. Treasury Secretary Janet Yellen point to the possibility of an increase in interest rates in the near future. This is typical of an economic cycle, particularly after a recession and period of fast growth, to prevent prices from getting too high.
Some of the classic advice to investors for higher interest rate environments remains true, but since the current economy has been in a position it has never been in before, the markets could behave in unpredictable ways.
For example, when interest rates rise, investors are usually advised to buy into raw materials.
The prices of raw materials tend to remain stable or decrease as interest rates rise. As the cost of these materials drop, the companies using them slightly edge out better profit margins. Raw material companies have traditionally been seen as hedges against inflation for this reason.
In 2020, though, the opposite rang true. Raw materials have actually contributed to inflationary pressures as a result of the pandemic. With global trade restrictions, the movement and supply of raw materials also came to a halt. At the same time, the U.S. housing market unexpectedly began to boom. Typically during a recession, operations depress somewhat equally. In our last recession for example, the housing market actually crashed, as did prices for just about everything, raw materials included.
During the pandemic, on the other hand, people began buying homes at such an alarming rate that the supply of raw materials could not keep up with demand, thus surging prices on lumber, steel, copper and other building materials. So the typical advice of buying into raw materials might not bode well for investors this time around — prices might taper off slightly if interest rates rise, but likely not in the same way they have during past cycles.
Real estate has also historically been seen as a hedge against inflation, but post-pandemic, it might be worth reassessing whether it’s currently an adequate safety-net for investors. The entire market is waiting for the housing bubble to burst, and rising interest rates might just be the catalyst needed. The housing market is already inflated as a result of the pandemic. Artificially surging prices will need a correction, and if investors choose to buy into real estate or real estate investment trusts now, given the current market conditions, they could see a decline in their investments.
When traders sense an increase in rates, they tend to move into exchange-traded funds and other funds. Of particular interest this year will be health sector funds, as they have boomed since the pandemic, and an increase in interest rates could boost their performance.
Pay. Off. Your. Debt.
One of the worst things an investor can have on their hands in a high interest rate environment is debt. You will end up paying even more than you already are in interest. With stimulus checks still being sent out and the possibility of more money on the way, make this the priority.
Don’t listen to those who say to dump cash during inflation.
You will often hear people advise you not to hold as much money in savings during inflationary periods, as the value of the money decreases. The stock market tends to outpace inflation, but we’ve never never been in a post-pandemic market before and don’t know if that will hold true. If 2020 taught us anything, it was that we can never have too big of an emergency fund. There is nothing more important now than safeguarding against the unexpected, and the average American should have at least nine to 12 months of savings on hand. Markets have been behaving unexpectedly for the past year, and it would be unwise to play the market unless your savings are already tightly secured based on conventional advice.
Review Your 401(k)
Most people invest through their 401(k), and this is one of the safer ways to play defense against high interest rates. It’s a good idea to invest in companies that produce necessities and utility products during inflationary periods. For example, toilet paper, paper towels, meat, milk, pharmaceuticals — these are all things you and others will buy regardless of their increase in price. Electric, gas and oil companies are also a good bet, especially with the increased demand they will see post-COVID.
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