10 Ways to Profit From an Interest Rate Increase
An interest rate hike in the near future seems all but a foregone conclusion heading into 2016. Although many investors and analysts are focused on the fact that they have been held artificially low for the past several years, interest rates have been declining since the early 1980s. Given this protracted period of declining rates, it is more likely that once rates do begin to rise, a trend of rising interest rates could continue for several years to come. Rising rates change the landscape of the marketplace for businesses and individual investors.
1) Invest in Brokerage Firms
Brokerage firms earn money from the interest earned on cash balances held in client accounts. Naturally, they earn more interest when rates are higher. A review of the 2003-2004 period, when the federal funds rate rose from 1.25 to 2.25%, shows that major online brokers such as E*Trade and Charles Schwab enjoyed a 38% increase in interest income and a resulting 10% improvement in operating profit margins.
2) Invest in Cash-Rich Companies
Cash-rich companies will also benefit from rising rates, earning more on their cash reserves. Investors can look for companies with low debt/equity (D/E) ratios or companies that have large percentages of book value in the form of cash.
3) Lock in Low Long-term Rates on Existing Financing
Individuals with adjustable-rate mortgages (ARMs), or companies with adjustable rate financing of any kind, would be well-advised to refinance with fixed rate financing, locking in the lowest possible interest rates for the long term.
4) Buy With Financing Now
Individuals or businesses planning major purchases or capital expenditures should consider going ahead and buying now while they still have the ability to lock in low long-term rates. Purchases made before interest rates begin to rise can result in substantial savings in financing charges and overall long-term costs.
5) Invest in Technology and Health Care Stocks
Most companies in the technology and health care sectors hold onto greater amounts of profits as retained earnings to reinvest in growth, rather than paying them out in the form of dividends. Past history shows that such a stance usually leads to increased revenues in a rising rate environment. In the past 13 periods of rising interest rates over the past half century, the health care and technology sectors experienced average gains of 13 to 20% during the first year following an interest rate increase. In comparison, overall average gains for the S&P 500 Index were only between 6 and 7%.
6) Go With Shorter Term or Floating Rate Bonds
Bond investors can decrease portfolio volatility during rising rate environments by moving to bonds with shorter terms to maturity or by purchasing bonds with coupon rates that float in concert with the market rate.
7) Invest in Payroll Processing Companies
Payroll processors, such as Paychex and Automatic Data Processing, customarily maintain large cash balances for customers in the periods between paychecks, when the money is distributed as payroll. These firms should see improved interest revenues when interest rates rise.
8) Sell Assets
Individuals or businesses with unneeded property or other assets may be able to profit from selling such assets before rates begin to rise. Buyers are likely looking to buy now when they can still lock in low, long-term rates, so they may be willing to pay premiums to acquire needed assets before rates begin going up.
9) Lock in Long-Term Supply Contracts
Rising rates generally mean rising prices as well. Businesses that can lock in long-term contracts with suppliers may be able to enjoy better margins by avoiding increased prices for as long as possible.
10) Buy or Invest in Real Estate
Real estate prices tend to rise with, and often even outpace, rising interest rates. Buying real estate or investing in real estate investment trusts (REITs) are another way to realize profits from a rising rate environment.