When interest rates hover near historic lows for extended periods of time, it becomes easy to forget that what goes down will eventually come back up. However, rates will generally begin to rise as an economy rebounds. When this happens, both short- and long-term fixed-income investors who are caught unprepared may miss out on an easy opportunity to increase their monthly incomes. Therefore, now is the time to begin preparing for this shift in the interest rate environment. Let's explore some of the basic, time-tested strategies that any investor or trader can use to profit in a rising interest rate environment.
Look to Stocks
Not all strategies that profit from rising rates pertain to fixed-income securities. Investors looking to cash in when rates should consider purchasing stocks of major consumers of raw materials such as gold. The price of raw materials often remains stable or declines when rates rise. The companies using these materials to produce a finished good - or simply in their day-to-day operations - will see a corresponding increase in their profit margins as their costs drop. For this reason, these companies are generally viewed as a hedge against inflation. Often when people hear invest in stocks, they associate stocks to the stock market. This is in fact not always the case. Much more equity is being placed in private equity investments than the stock market. The reasoning? Preception of more immediate control, more knowledgeable investors and greater returns.
Get Your Ladder Ready
Of course, the most common strategy that financial planners and investment advisors recommend to clients is the bond ladder. A bond ladder is a series of bonds that mature at regular intervals, such as every three, six, nine or 12 months. As rates rise, each of these bonds is then reinvested at the new, higher rate.
Don't Forget the Dollar
Those who invest in foreign currencies may want to consider beefing up their holdings in good old loonie. When interest rates start to rise, the dollar usually gains momentum against other currencies because higher rates attracts foreign capital to investment instruments that are denominated in dollars, such as T-bills, notes and bonds.
Reduce Your Rise
Rising interest rates mean that more conservative instruments will begin paying higher rates as well. Furthermore, the prices of high-yield offerings will tend to drop more sharply than those of government or municipal issues when rates increase. Therefore, the risks of high-yield instruments may eventually outweigh their superior yields when compared to low-risk alternatives.