The Federal Reserve is finally recognizing just how entrenched inflation has become and looks like it might actually take some serious steps to at least start to address it. Key among those steps is raising interest rates.
Interest rates have been in a downward trend for around 40 years — since the last time inflation spiked this high — which makes a rising rates environment something many investors have not experienced. The investing roadmap is a little bit different when interest rates are going up, so knowing how to invest when interest rates rise is a skill that it makes sense to learn. These five strategies can help you navigate what could otherwise be a rocky patch in the market.
No. 1: Get your own balance sheet under control
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Rising interest rates mean that the cost of being in debt will increase. If you have variable-rate debts or debts that you will need to borrow more to pay off when they mature, now is a great time to figure out how to pay them off or lock in fixed rates for them. The higher rates rise, the more expensive variable-rate debts will become, and the more expensive it will be to take out new fixed-rate loans, as well.
By getting your debts paid off or refinanced while rates are still fairly low, you can keep control of more of your income and cash flow. That is an important part of being able to assure that you have money available to invest in the first place.
No. 2: Keep your bond duration fairly short
If your financial allocation plan calls for you to own bonds, then in a rising rate environment, you’ll want to make sure the bonds you own are fairly short duration ones. This is because the longer a bond’s duration, the farther it will fall when interest rates rise.
If your intent is to keep your bonds until they mature, your bonds’ cash flows won’t change just because interest rates rise. If you use your bonds as portfolio ballast or plan to sell them before maturity, however, recognize that bonds with low coupons and long times until they mature can fall quite far as rates rise. Those are the types of bonds that generally have longer durations and thus are more affected by rising interest rates.
No. 3: Look out for your stocks’ balance sheets
The same risks that affect your ability to pay your debts when interest rise also …….