With its first interest rate increase in years, the Federal Reserve appears set to move ahead with its plan to continue boosting rates several more times through the end of the year. After going through much of 2020 and 2021 in a zero-rate environment, investors got comfy with a very accommodative Fed, which floored the gas pedal to help the economy through the pandemic. But now with a much stronger economy and raging inflation, the nation’s central bank is hitting the brakes, making things harder for stock investors and others.
So how do investors continue to invest in this climate and how can they use ETFs to do it? Here are some of the best ETFs for investors looking to defend, and even thrive, amid rising rates.
Which types of ETFs tend to perform well when rates rise?
With rates poised to rise, potentially for years, investors are looking for the best industries and investments that can thrive in that environment. The types of investments that tend to do well as rates rise include:
- Banks and other financial institutions. As rates rise, banks can charge higher rates for their mortgages, while moving up the price they pay for deposits much less. (That’s one reason to focus on finding a high-yield online savings account.)
- Value stocks. Stocks trading at a relative discount tend to do better as rates rise and investors turn away a bit from “growthier” or riskier names.
- Dividend stocks. Companies that pay dividends also seem to perk up as rates are rising, and many are typically value stocks, too.
- The S&P 500 index (
). Stocks often decline at first as the market prices in higher rates, but it’s key to remember that rates are usually rising because the economy is robust and companies are doing well. So, a diversified set of stocks can also rise as rates are climbing higher.
- Short-term government bonds. Yes, rising rates hurt bonds, but very short-term bonds feel minimal negative effects and the yield of new issues climbs as rates rise. Combine it with government backing and you have about as safe an investment as you’ll find.
While stocks may offer the most upside over time, investors sometimes need access to the safety of bonds – yes, even amid rising rates. That’s why it’s important to have a “go-to” bond ETF with low downside and the prospect of an annual yield, too.
Best ETFs for higher interest rates
The ETFs included below hail from the categories above, and they also offer a low expense ratio, helping you to minimize your out-of-pocket costs. (Data as of March 16, 2022.)
1. Vanguard Value ETF
The Vanguard Value ETF (
Yield: 2.2 percent
Expense ratio: 0.04 percent
2. Schwab US Dividend Equity ETF
This ETF (
Yield: 2.9 percent
Expense ratio: 0.06 percent
3. Vanguard S&P 500 ETF
With a well-diversified portfolio of stocks from every major sector of the economy, the Vanguard S&P 500 (
Yield: 1.3 percent
Expense ratio: 0.03 percent
4. Goldman Sachs Access Treasury 0-1 Year ETF
Yes, a bond fund makes its appearance here, not because it’s going to provide stellar returns, but because it can fill a niche in your portfolio when you need a good, safe place to park cash. With investments in very short-term U.S. Treasury bills, this ETF (
Yield: 0 percent
Expense ratio: 0.12 percent
5. Invesco S&P SmallCap Value with Momentum ETF
This Invesco ETF (
Yield: 1.2 percent
Expense ratio: 0.39 percent
6. Financial Select Sector SPDR Fund
If you want concentrated exposure to financial companies in the S&P 500, you can do that with the Financial Select Sector SPDR Fund (
Yield: 1.7 percent
Expense ratio: 0.10 percent
7. Vanguard High Dividend Yield ETF
The Vanguard High Dividend Yield ETF (
Yield: 2.8 percent
Expense ratio: 0.06 percent
Whether you go with one or more of these ETFs or another entirely, it’s important to remember that investing in stocks requires you to invest long term, at least three to five years out. With that kind of time frame, you can ride out the volatility in the market and potentially enjoy some of the attractive long-term returns that stocks can offer.
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