How to Invest When Interest Rates Rise!
Investing when interest rates rise can be a challenge, but it doesn't have to be!
As a real estate investor myself, I learned that the BEST thing that can happen to your portfolio is a downturn.
(You can buy assets for such a discount, it feels like thrift shopping!)
Before getting too ahead of ourselves now.
Here are a few tips to help you make the most of your investment dollars when rates are on the rise:
1. Don't panic. This is probably the most important tip of all. When rates go up, it can be tempting to sell everything and run for the hills. But resist the urge to panic. Instead, take a deep breath and reassess your investment goals.
2. Review your portfolio. Once you've calmed down, it's time to take a look at your portfolio and see how it's performing. Are there any investments that are no longer meeting your needs? If so, it may be time to sell them and reinvest the proceeds into something else.
3. Consider your options. When interest rates go up, it can be a good time to invest in bonds… Or cheaper equities instead! Don’t bind yourself down and remember to avoid the madness of the crowd.
4. Cash is king. When interest rates rise, cash becomes a more attractive thing to own. This is because you can gain new assets using excess cash, without claiming losses on other assets (like stocks.).
5. Stay diversified. Finally, remember to stay diversified. This means investing in a variety of different asset classes, including stocks, bonds, and cash. By diversifying, you'll be able to weather any storms that come your way.
Investing when interest rates rise can be tricky, but following these tips can help you make the most of your investment dollars.
Watch the video instead
What is the risk of investing when interest rates rise?
Bond prices decline as interest rates rise, reducing the returns on investors' money. This is because the market has less overall velocity, so lower expected returns.
If you’re not a bond magnate (like me) then you also need to understand the other implications of high interest rates.
Example: If you're trying to save up for a down payment on a house, for instance, but your income has been fluctuating, you may need to increase your monthly savings JUST to maintain.
Example: let’s say you aren’t an oracle with a crystal ball. To save money you opted into a variable mortgage rate. The rate was less than 3% when we started making payments and by the height of interest rates, it rises to 4.45%.
Since you pay interest before principal, you will see a material rise in home payment cost.
The future of your retirement funds may be drastically altered if you are now saving for it.
And if you're a retiree or stay-at-home parent who depends on your investment income to pay the bills each month…
A deficit in net earnings could have a devastating effect on your quality of life.
The importance of time horizons
Taking the time frame of your investing strategy into account can help you deal with changes in interest rates.
Bonds and certificates of deposit (CDs) are examples of investments that pay a set interest rate and mature at a certain time.
When the investment matures, you will get back the amount you put in plus any interest that has been earned.
If interest rates go up before your investment is paid off, you will get less true value from what you put in… But as promised, you will get your original investment back plus interest.
There is no “crash” in a bond scenario in comparison to equities.
If you don't know when an investment, like stocks, will mature, it's hard to guess how much money you'll make over time.
I recommend that you do your best to think long term whenever possible.
It makes for more prudent decision making (and goofing up less!)
Strategies to reduce exposure in rising rate environments
When interest rates go up, you can protect your investment capital in a few ways.
When you invest in both stocks and bonds, you can spread out your risk and increase the amount of money you could make.
Do you reeeeally need 97% of equities in blue chip?
They’re generally the most inflated, and thus subject to correction in economic downturn.
Even though the performance of a balanced portfolio may be different from that of an all-stocks portfolio, the latter gives a more steady flow of income over time.
By NOT losing money, you’re already outperforming the market.
Investing in companies that pay dividends is another way to lessen exposure.
Mythical example: if a REIT is valued at $20/share and offers 10% quarterly dividends to each LP (limited partner.)
You own 1,000 shares so that’s $500 a quarter of income:
Earning = Valuation x Dividend Yield / Payout Period
Earning = $20,000 x 0.10 / 4
Earning = $2,000 / 4
Earning = $500
Now let’s say the valuation decreases by 25% due to a lack of liquidity:
This means your 1,000 shares are now worth $15,000.
Earning = Valuation x Dividend Yield / Payout Period
Earning = $15,000 x 0.10 / 4
Earning = $1,500 / 4
Earning = $375
So, in this scenario you lost 25% of your take home,
That being said, it’s not so bad considering that you can still purchase REIT shares at discount.
The bonus liquidity offers more optionality for discounted assets, without incurring substantial losses.
During this time, dividend-paying companies do better than those that don't.
If you're worried about the market and interest rates are going up, for example, you might sell some of your stocks and put the money you get from that into bonds or other low-risk investments.
The stock market is affected by interest rates in a big way.
The value of stocks usually goes down when interest rates go up, but long-term investors can usually recover from short-term market volatility.
It's important to keep an eye on interest rates and look for signs that they might go up.
When rates do go up, you can get ready for possible changes in the market by changing how you invest and/or making your portfolio more diverse, as needed!