With your savings account earning close to nothing in interest, it’s hard to believe there was a time – possibly in your lifetime, back in 1981 – when even a lowly, no-risk, 6-month certificate of deposit (CD) was paying back almost 18%.
While few are predicting a return to those days anytime soon, and after being anchored near zero for about 8 years, interest rates have finally started to get off the floor. Investors may be wondering what this could mean.
Income investors—those who want their investments to return real money that they can spend now rather than seeking capital growth for the future—may be looking at their next steps. Bonds? Stocks? Anyone remember when NOW accounts were all the rage?
The Federal Reserve Board has twice raised interest rates since the November election, and some online banks are now offering more than 1% interest on savings. The yield on the 10-year Treasury bond (money that is lent to the government in exchange for interest payments) crept up from a record low of 1.375% in July 2016 to something closer to 2.6% in March of 2017.
Transamerica Senior Investment Analyst Kane Cotton, CFA®, reviewed this year’s prospects with an eye toward investment classes that may benefit from or protect against rising interest rates. He came up with a few things to keep in mind in a rising rate environment.
- Riding the tide. Short-duration bonds (basically short-term loans you may make to a government or a company with a term of less than three years) can deliver returns that are less sensitive to changes in interest rates than longer dated bonds. You can even “float” up or down with interest rates with something called a “floating rate” fund. These funds are made up of bonds that make coupon payments which rise and fall with market interest rates such as the London Interbank Offered Rate (LIBOR). While they do carry credit risk, this floating rate feature typically means less sensitivity to changes in market interest rates. A financial professional can help with bond and fund investments.
- Getting “real.” Seeking a real or “inflation-adjusted” return can lower correlation to the market. U.S. Treasury inflation-protected securities (called “TIPS”) periodically adjust their principal for inflation with the intention of allowing an investor’s returns to outpace inflation over time.
- Being active. Actively managed, multi-sector funds with flexible mandates may be able to shift allocations to sectors that are less correlated to interest rates. They can also pursue opportunities to earn higher yields.
- Getting credit. Consider taking on some credit risk in place of interest rate risk by looking at investments with a yield that’s better than U.S. Treasury’s. Consider credit such as investment grade or high yield corporate bonds.
- Going global. When U.S. rates rise, foreign markets may offer attractive opportunities, relatively speaking. Interest rate cycles can differ by country and region. Look at corporate and government debt opportunities in overseas markets to seek returns and diversify risk in rising rate environments.
Looking ahead, Transamerica Asset Management Chief Investment Officer Tom Wald, CFA®, sees the potential for at least two more interest rate increases from the Fed in 2017. Wald says income investors may want to keep an eye on interest rate risk and focus attention on short-term bonds, floating rate notes, preferred stocks, high-yield bonds, and high-dividend stocks. Wald believes a combination of these asset classes could help investors mitigate overall interest rate risk while achieving yield in what is still a low rate environment by historical standards.
And since nobody can predict the future, Wald suggests seeking out an expert who can help you decide what course of action is best for your individual situation.
“In a potentially rising interest rate environment that may include more risk, we believe it makes sense to take advantage of the expertise and capabilities of a seasoned portfolio manager who understands the implications of the new rate cycle we could be entering,” Wald said.
What ideas have you heard? Any lessons from the last time interest rates rose?
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