How to Invest for Rising Interest Rates

Many investors know that interest rates have a big impact on their debt. After all, when interest rates rise, the cost of borrowing goes up. But did you know that rates can also affect your investments? Although many investors and analysts focus on interest rates being low, rising interest rates change the landscape of the marketplace for businesses and individual investors. Here's how investors can profit from rising interest rates.

Key Takeaways

  • Interest rates should be a factor that investors should consider when crafting or readjusting their portfolios.
  • Investing in rising interest rates can be done by investing in banks and brokerage firms, tech and health care stocks, and companies that have a large cash balance.
  • You can capitalize on higher rates by buying real estate and selling off unneeded assets.
  • Short-term and floating rate bonds are also good investments during rising rates as they reduce portfolio volatility.
  • Hedge your bets by investing in inflation-proof investments and those with credit-based yields.

1. Invest in Banks and Brokerage Firms

Banks and brokerage firms earn money from interest. This means they can earn more when rates are higher as credit isn't as readily available during these times. As such, consumers are willing to pay more to borrow. When the Fed has raised interest rates in the past, financial services firms like banks and brokerages have seen an improvement in interest income and operating profit margins.

On the other hand, borrowers tend to have more money in their pockets when interest rates are low. This means they often make larger purchases and borrow more during this time. As such, banks can make money off of the interest they earn in larger volumes. Even when rates are low, banks remain profitable because of the fees, commissions, and service charges they collect from their clients.

2. Invest in Cash-Rich Companies

Cash-rich companies benefit from rising rates because they earn more on their cash reserves. Investors can look for companies with low debt-to-equity (D/E) ratios or companies with large percentages of book value in the form of cash. Companies that hoard cash are also a great opportunity, including names like Apple (AAPL). which had $63.91 billion for the final quarter of 2021.

3. Lock in Low Rates

You can take advantage of cheaper borrowing costs by locking in low-interest rates by taking out variable or adjustable-rate credit. These products are those that have low introductory rates that are adjusted based on market conditions. So if rates rise, so too does the rate on your loan or mortgage.

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. 

Whether you're a novice investor or are very experienced, it's always a good idea to consult a financial professional about any changes you make to your investment portfolio or strategy.

4. Buy With Financing 

Individuals or businesses that are planning on making major purchases or capital expenditures should consider buying now while they still have the ability to lock in low long-term rates.

Purchases made before interest rates begin to significantly rise can result in substantial savings in financing charges and overall long-term costs.

5. Invest in Technology, Health Care

Dividend-paying companies are favored by many investors because they share a portion of their earnings with shareholders. But if you're looking for a form of long-term growth with interest rates in mind, you may want to look elsewhere.

Companies in the technology and health care sectors tend to hold on to greater amounts of profits as retained earnings to reinvest in growth opportunities, rather than paying them out in the form of dividends. Past performance shows that during periods of rising interest rates, the health care and technology sectors experienced average gains that outperformed the S&P 500 Index.

6. Embrace Short-Term or Floating Rate Bonds

Diversifying your portfolio is important during times of uncertainty. This includes finding new sources of income, especially when interest rates rise and inflation becomes a threat to the economy.

Bond investors (and any other investor, for that matter) can decrease the volatility in their portfolios during rising-rate environments by moving to or investing in bonds that have short-term maturity dates or by purchasing bonds with coupon rates that float in concert with the market rate. 

Just remember that fixed-income vehicles aren't the only types of investments that you should consider. Having a strategy that encompasses a multi-asset approach can certainly help curb market risks and ensure a better return on investment (ROI).

Investing with portfolio managers who have a flexible approach can help you preserve your capital. These professionals are able to make changes to sector weightings and duration exposures as per market and interest rate swings.

7. Invest in Payroll Processing Companies

Payroll processors generally maintain large cash balances for customers in the periods between paychecks, which is when the money is distributed to their employees as payroll. These firms should see improved interest revenues when interest rates rise.

Some of the most common names in this industry include:

  • Paychex (PAYX)
  • Automatic Data Processing (ADP)
  • Paylocity (PCTY)

8. Sell Assets

Individuals or businesses with unneeded property or other assets may be able to profit by selling these assets before rates begin to rise. Buyers are likely looking to buy when they can still lock in low, long-term rates from their lenders, 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 don't just mean higher profits for those who sell their products and services to consumers. They also mean rising prices as well.

Just like consumers end up paying more in interest when they borrow from banks and other lenders, businesses also have to consider what higher rates mean for their bottom lines. 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, interest rates. Buying real estate or investing in real estate investment trusts (REITs) is another way to realize profits from a rising rate environment.

Rising interest rates may sound like a bad thing for those who need to take out a loan or buy something on credit, but investors can profit by planning ahead and purchasing the right types of investments.

Inflation Hedge

As noted above, inflation has a big impact on investments. When inflation isn't as rampant, central banks are more likely to keep interest rates low. But rising inflation means higher prices, which leads to higher interest rates. Investors should, therefore, find a way to hedge the risks of inflation. But how do you do it?

The best way to do so is to find investments that are better equipped to deal with the shocks of high or rising interest rates. These vehicles include:

You can also hedge your bets against inflation by investing in the equity market. U.S. equities provide investors with safety because of the favorable economic conditions in the country. International equities can also benefit investors because of fairly attractive valuations in these markets. You can also look for security in companies that can grow their dividends and have a good influence on pricing in the market.

Credit-Based Yield

Investors have traditionally been able to offset changes in interest rates by investing in certain fixed-income vehicles that provide a hedge against lower prices. This was done through things like government debt. But their low yields are forcing investors to look elsewhere for a greater degree of income. That's where credit-based yields come into play.

The following are some of the key places you can look to in order to maximize your returns and help you benefit from changing interest rate environments:

Are Bonds Good Investments When Interest Rates Rise?

Rising rates aren't so great for bonds in the short term. Bond yields have an inverse relationship with interest rates. When rates rise, bond yields tend to fall and vice versa. Those with longer-term maturity dates tend to lock in rising interest rates for more time. But short- to mid-term bonds tend to do better in this kind of environment, so how interest rates affect yields depends on the type of bond you hold.

Do High Interest Rates Attract Investments?

Yes, higher interest rates tend to attract more foreign investment. That's because rising rates increase the value and demand for their own currency. On the flip side, a low-interest-rate environment often keeps these investors away because the value of their own currency can decrease.

What Happens to High Yield Bonds When Interest Rates Rise?

Bond yields have an inverse relationship with interest rates so when rates drop, yields rise. When rates rise, bond yields drop. Having said that, even high-yield bonds are affected. Keep in mind, though, that these investments often come with a higher payout and bondholders are paid out before shareholders if the issuing companies goes under.

The Bottom Line

As an investor, there are a number of factors that you should consider when you're developing your investment strategy. Although they may not seem as important, interest rates should be one of those considerations. Not only do they affect the cost of borrowing, but they also have a big impact on how your investments perform. By using the tips provided above, investing with interest rates in mind can help increase your return on investment.

Article Sources
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