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Investing when rates are rising |
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Investing When Rates are Rising
Interest rates are on the rise. Nobody knows how fast or how far rates will go, but one thing is certain; they'll continue to affect financial markets. That means you should be aware of the potential impact of a changing rate environment on your investment portfolio.
Rate increases are good for investors who have cash available to invest. If you're a conservative income investor, rising rates are probably good news because when rates increase, so do the rates available on GICs, term deposits, bank deposits and similar investments.
But upward rate moves aren't kind to those who already own fixed-income investments such as bonds. That's because the prices of existing bonds fall as investors are no longer willing to pay as much for these lower-rate securities at a time when newly issued bonds offer higher interest payments. However, the impact varies widely within the bond market because shorter-term securities are typically less volatile than intermediate or longer-term bonds.
Although nothing is written in stone, stocks tend to outperform bonds in a rising rate environment. But it depends which sector of the stock market you consider. Interest-sensitive stocks, such as utilities, react poorly to rate increases because these companies borrow large amounts of money and face higher interest costs. Meanwhile, companies that benefit from the strong economy that accompanies rising rates, such as businesses that produce consumer goods, may do better as sales and profits increase.
Because the impact of rates varies widely, diversification is your best strategy. When you include all the major asset classes in your portfolio you'll weather volatility by taking advantage of securities that perform best when rates rise and limiting exposure to those that underperform.
There are other steps you can take
If you invest in income securities such as GICs or bonds, don't lock in all your money for longer terms if you think higher rates are around the corner. Instead, "ladder' your investments by committing to various terms. This lets you take advantage of the best rates available at any time, but doesn't lock in all your funds for the long-term. A portion of your portfolio will be available for reinvestment each year at higher rates. But if rates stay the same or move lower, then most of your money is still earning that higher rate.
If you're uncertain about the direction or velocity of rates, consider keeping part of your portfolio in cash investments, such as money market mutual funds, until the investment climate becomes clearer. These low-risk investments will earn more as rates rise, but be aware that returns will typically be lower than those offered by other types of investments. So keeping money in short-term holdings for too long can result in missed opportunities. In addition, you should consider that owning too much short-term investment increases reinvestment risk. Short-term rates can be quite volatile, and should short-term rates unexpectedly drop, you could experience a significant decrease in income.
And finally, consider mutual funds. Fund portfolios are managed to make the most of rate changes. This may be a better solution in volatile times than trying to buy and sell individual securities. |
