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Written by Guest Contributor: Paul A. Werlin, President, Human Capital Resources, Inc.
There’s little doubt that after almost 15 years (2008) of declining and near zero interest rates, we’re finally going to see interest rates rise. In fact, indications are that the US Federal Reserve will bring 3 or 4 rate increases to the Federal Funds Rate, which is the base rate that virtually all other interest rates are tied. For savers, this is actually good news—every retiree wants to see the returns on their “safe money” go up for money market funds which are now pay about 0.5% or for 15-month bank CDs that currently pay 1.15%. With taxes and inflation, you know you that you’re actually losing money holding these investments.
For savers, higher interest rates may be good, but, what about investors? If higher rates are inevitable, are there steps we can take to protect our assets and even take advantage of the changes to come? Contrary to what you might think, historically, stocks have performed pretty well during periods of rising interest rates. While that may sound wrong, keep in mind that companies are actually experiencing strong growth while interest rates are being pushed up, so their earnings and stock prices may also rise.
In fact, during Fed rate-hike periods, the Dow Jones Industrial Average DJIA, rose nearly 55%, the S&P 500 62.9% and the Nasdaq Composite has averaged a positive return of 102.7%, according to Dow Jones, using data going back to 1989.
Fed interest-rate cut periods also yield good gains-but not as good, with the Dow up 23%, the S&P 500 gaining 21% and the Nasdaq rising 32%, on average. While the past is not always 100% right about the future, if you’re a long-term investor, it’s probably best to just stay invested. As for bonds, you should also probably avoid longer-term fixed income assets: bonds lose value over time if the interest they earn is below the rate of inflation. If you hold bonds in your portfolio, short-term bond funds are going to be less risky in a rising rate environment.
Historically, there are investments and sectors that tend to do better in periods of rising rates. As for stocks, look for large well-established companies with a history of dividend growth. These tend to be companies that are leaders in their industries, have products and services that are in strong demand, have a history of consistent dividend payouts are also good assets to own as interest rates rise. Yet again, see my post 154 last year on “Dividend Aristocrats” for good candidates. Utilities and REITs (real estate investment trusts) may do well in this environment.
You might also look at financial services companies. For example, banks tend to do well in a strong economy with higher interest rates since they will be able to charge more for things like loans and home mortgages and keep a good percentage after paying their expenses and depositors. If you're a long-term investor with a diversified portfolio, selling to go to cash will almost certainly be a mistake.
Whether in a rising or falling interest rate environment, the truth remains that the best strategy for the long-term is to have a plan, get professional help, be diversified, make changes/modifications as circumstances change, and perhaps most importantly, don’t panic.
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