Higher interest rates are finally here, and many investors are scrambling to figure out what to do.
After the Federal Reserve raised rates in September to a range of 2.0% to 2.25%, we’ve seen some serious changes in the investing landscape. The rate on the 10-year Treasury hit a seven-year high of 3.25% this week, and the S&P 500 (.SPX) has been falling for much of this month.
While it’s important to keep a long-term perspective with your investments and not make hasty decisions, certain strategies are better suited for a rising rate regime than others. Whether your taste in risk runs spicy, medium or mild, these are some trades to consider:
3X Inverse Treasury Bonds ETF
When interest rates go up, bond prices go down. So why not bet big on this fundamental truth with Direxion Daily 20+ Year Treasury Bear ETF (TMV)? The fund seeks to generate three times the opposite daily movement of long-term U.S. government bonds. That’s great if rates rise and bond prices fall — this fund up over 15% in the last 30 days — but obviously will be not so hot if rates falter and bond prices rise once more.
An inverse real-estate fund
A more indirect way to profit from the pain caused by higher rates is through the Pro Shares Short Real Estate ETF (REK).This fund moves in the opposite direction of the Dow Jones U.S. Real Estate Index, an index that includes residential plays such as AvalonBay Communities (AVB) as well as commercial real-estate plays like mall operator Simon Property Group (SPG). Higher rates mean higher borrowing costs, which could impact demand and occupancy across all real estate segments.
Of course, one segment of the market that quite literally never needs to borrow is Big Tech. As of its last quarterly report, Apple Inc. (AAPL) had $71 billion in cash and $172 billion in long-term investments. Microsoft (MSFT) posted $133 billion in cash and equivalents. Sure, there’s volatility in the sector right now, but it may be wise to make bargain buys in behemoths with deep pockets.
The fact that gold investments like the popular SPDR Gold Shares ETF (GLD) tends to rise during periods of inflation hints that this could be a wise investment in times of rising rates, too. After all, rate hikes are normally driven by fears of inflationary pressures. Similarly, gold is an asset largely uncorrelated to stocks so it could give you a place to hide from market volatility or interest-rate risks. Just remember that gold is not a bulletproof investment either, and can come with extreme volatility of its own — particularly if conditions change.
Big banks like JPMorgan Chase (JPM) or Bank of America (BAC) will naturally raise borrowing costs on all kinds of loans and lines of credit as interest rates rise, but it’s naive to think they’ll also pass those rates on to savers. Instead, they’ll simply enjoy better margins. Similarly, insurance companies like Chubb Ltd. (CB) and American International Group (AIG) will profit from the “float” of premiums from their customers they can reinvest in low-risk interest-bearing assets. A diversified way to play this trend is the Financial Select Sector SPDR ETF (XLF).
Short-term corporate debt
Short-term bonds have less interest-rate risk than those with a decade or more to maturity. That’s good amid rising rates, but the trade-off is sacrificing some yield as you shorten your duration. The Vanguard Short-Term Corporate Bond ETF (VCSH) is a middle road, then, with a focus solely on corporate debt that can yield more than Treasurys. Right now the fund is down about 2% year to date and has a yield of 3.5%, compared with the decline in the iShares 20+ Year Treasury Bond ETF (TLT) of 9% with a 30-day yield of just 2.7%. Sure, it’s down — but is a much better alternative to long-term Treasurys.
If you don’t want an aggressive or tactical bet that tries to anticipate the future of interest rates, then consider the iShares Floating Rate Bond ETF (FLOT) that adjusts rates to keep up with the market in an attempt to protect your principal. That shows in that the ETF is pretty flat year-to-date while conventional bond funds have stumbled, but still offers a decent 2.6% yield. You won’t necessarily get the full income potential of a higher-rate environment, but you avoid the principal risk.
Another strategy to mitigate rising rates is to “ladder” your bond portfolio by ensuring the maturities cascade over time instead of coming due all at once. That allows you to slowly transition into newer, higher-yield bonds without selling out early and taking a principal hit. If this sounds like a lot to manage on your own, then consider the Invesco LadderRite 0-5 Year Corporate Bond Portfolio (LDRI) that takes short duration bonds and ladders them for investors. The yield is about 3% at present and should rise over time, and the principal value is rock steady over the long term.
High-yield savings account
Your principal is safe in a jumbo CD, and current rates online are in the ballpark of 2.1% for the best offers if you have more than $5,000 and are willing to give up some liquidity with a 12-month investment. If you can tie up funds for 18 months, the annual percentage yield can jump up to 2.7%. Considering that short-term bond funds like the SPDR Portfolio Short Term Treasury ETF (SPTS) only offer about 2.2% at present but still carry some investment risk, you may be better off simply shopping around for a CD instead of exploring Treasury bond funds with shorter durations.
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