On Dec. 13, 2017, the Federal Reserve announced it was increasing the federal interest rate to 1.5 percent, a 0.25 percentage point increase from the previous rate. When interest rates rise, the cost of borrowing money increases — though, even with the increase, rates are still relatively low when compared to historic averages.
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In light of the rate increase, anyone taking out new loans will pay more in interest, and lenders will receive more interest income. And changes in interest rates have a ripple effect across the economy — including on your investment portfolio. Here’s what you can do to maximize your investment strategies in this environment of rising interest rates.
6 Wise Investment Moves
When interest rates rise, you should review your investment strategies and make changes. Here are several principles to consider:
1. Sell Bonds and Hold Cash as Rates Rise
When interest rates rise, fixed-rate bonds decline in value because the interest rate is fixed. As a result, investors won’t pay face value for existing bonds but will instead expect a discount, decreasing the market value of the bonds.
By selling bonds now and holding cash until interest rates rise in the future, you can redeploy your cash in new bonds when the interest rates are higher. But you won’t have better bond opportunities going forward, and you won’t be earning much interest on the cash sitting in your account if interest rates don’t rise in the future.
Related: How to Choose the Best Bonds for Your Financial Plan
2. Consider High-Performing Sectors from Previous Rising-Rate Environments
In the past, energy, technology and healthcare companies have performed the best in rising-rate environments, according to a Fidelity study. But just looking at rising or falling interest rates ignores whether the economy as a whole is expanding or contracting, as well as other factors such as impending tax law changes.
For example, according to the same Fidelity study, technology stocks do well in a growing economy whereas healthcare stocks outperform when the economy slows. But keep in mind that past performance is no guarantee of future results.
3. Invest in Variable Rate Bonds
Look for bonds that pay a variable or floating interest rate rather than a fixed interest rate if you want to continue to deploy capital into the bond market. For example, a bond might have its interest set to 4 percent plus the Federal Reserve rate, so if the Federal Reserve rate increases from 1.5 percent to 2 percent next year, the interest rate on the floating-rate bond will increase from 5.5 percent to 6 percent.