On Dec. 13, 2017, the Federal Reserve announced it was increasing the federal interest rate to 1.5 percent, a 0.25 percentage point increase from the previous rate. When interest rates rise, the cost of borrowing money increases — though, even with the increase, rates are still relatively low when compared to historic averages.
In light of the rate increase, anyone taking out new loans will pay more in interest, and lenders will receive more interest income. And changes in interest rates have a ripple effect across the economy — including on your investment portfolio. Here’s what you can do to maximize your investment strategies in this environment of rising interest rates.
6 Wise Investment Moves
When interest rates rise, you should review your investment strategies and make changes. Here are several principles to consider:
1. Sell Bonds and Hold Cash as Rates Rise
When interest rates rise, fixed-rate bonds decline in value because the interest rate is fixed. As a result, investors won’t pay face value for existing bonds but will instead expect a discount, decreasing the market value of the bonds.
By selling bonds now and holding cash until interest rates rise in the future, you can redeploy your cash in new bonds when the interest rates are higher. But you won’t have better bond opportunities going forward, and you won’t be earning much interest on the cash sitting in your account if interest rates don’t rise in the future.
2. Consider High-Performing Sectors from Previous Rising-Rate Environments
In the past, energy, technology and healthcare companies have performed the best in rising-rate environments, according to a Fidelity study. But just looking at rising or falling interest rates ignores whether the economy as a whole is expanding or contracting, as well as other factors such as impending tax law changes.
For example, according to the same Fidelity study, technology stocks do well in a growing economy whereas healthcare stocks outperform when the economy slows. But keep in mind that past performance is no guarantee of future results.
3. Invest in Variable Rate Bonds
Look for bonds that pay a variable or floating interest rate rather than a fixed interest rate if you want to continue to deploy capital into the bond market. For example, a bond might have its interest set to 4 percent plus the Federal Reserve rate, so if the Federal Reserve rate increases from 1.5 percent to 2 percent next year, the interest rate on the floating-rate bond will increase from 5.5 percent to 6 percent.
4. Create a Bond Ladder
Different bonds have different durations, ranging from a few weeks to a century or longer. And a bond ladder is one of many investment tools that you can use to mitigate risk.
You can structure a bond portfolio to have a varying range of durations so that every few months or every year, a portion of your portfolio comes due and you can reinvest the proceeds. That way, if interest rates continue to rise, some of your bonds that have short durations will come due, and you can redeploy that money into new bonds. But, if interest rates stay flat or fall, you won’t have all your money sitting in cash.
5. Diversify to Include More Real Return Assets in Your Portfolio
Real return assets refer to assets that do well as a hedge against inflationary pressures, such as real estate, commodities and inflation-protected securities. These assets have traditionally performed well in rising interest rate environments, according to Fidelity, and they generally have a low correlation to stock and bond performance. Including them in your asset allocation will further diversify your portfolio if you choose to use this as an opportunity for portfolio rebalancing.
6. Review Your Financial Goals
Before you make any rash decisions because of the fed rate hike, review your personal goals to determine how to invest going forward. Especially for goals that are a long way in the future, make sure you’re sticking to your long term investment strategy with any moves that you make.
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