Any change in interest rates can drastically impact an investment decision, and this necessitates an investment strategy that fine tunes the investors requirements for maximum gain. What we detail in the following article will help readers assess how they can fruitfully initiate protective measures, and make the most of the opportunities that present themselves when interest rates change.
The art of rebalancing one’s portfolio in a changing interest rate scenario
This is the core protection parameter that all investors worth their salt prepare the ground for, when interest rates suffer a change. Investment portfolios cry for immediate adjustment when interest rates rise. The professional Banker, you will observe reallocates his capital to gear his organization to respond appropriately when a rate rise stokes fresh economic change. In much the same manner, the individual investor has to reassess his strategy to ensure his precious and limited capital resources are preserved, and his income remains stabilized and portfolio grows steadily.
The focus on Short-Term Bond Funds
This is a kind of bond fund that focuses on investments targeting fixed-income instruments that have short lived maturities, and they are a powerful hedge against rising interest rates. Through them, the investment gets rolled over into short maturity instruments that assure a higher return to offset the lowered returns that lowered interest rates create. The investor thus frees himself from the low interest-low rate of return cycle that would otherwise diminish his earnings. Of course, you would have to lean on the expertise of professional fund managers to leverage maximum returns through this strategy.
Not weirdos, this are Variable-Rate Demand Obligations (VRDOs)
Just like the short term bond fund, VRDOs offer another alternative for combatting the rising interest rate scenario – they enable a periodical adjustment mechanism to counter interest rate increase. There are other instruments like Treasury inflation-protected securities (or simply TIPS) that serve to eliminate inflation risk, even as they assure returns guaranteed by the U.S. government, but VRDOs guarantee protection against the risk of rising interest rates that impact returns severely. Tax exemption is also a benefit that, to a great extent, compensates for the opportunity cost one generally associates with high yielding instruments.
The mighty U.S. Dollar
It will be observed by keen watchers of the economy that the rising interest rate scenario pushes the dollar upwards, and this will usually match economic growth that is exhibiting tempered inflation. One strategy to make the most of such a situation is to offload stocks of multinational corporates that are in the process of repatriating capital homewards, and to leverage the cash to invest in domestic firms that are on a strong growth curve and which are promising higher dividends. This is one strategy to make the most of the rising dollar. Any interest rate boosted currency (dollar) appreciation can also be tackled using Dollar Index Funds.
Certificate of Deposit Ladders or CD ladders
The CD ladder is another way of capitalizing in an interest rate rise and currency appreciation (dollar rise) scenario. In a typical CD ladder the investor invests in sequential “same value” CDs that have differing maturities. This is a useful hedge when savings come under threat and returns are negatively impacted. The sequential laddering of CDs ensures that the interest rate enhancement risk and its negative impact on returns is minimized, just as one’s savings get maximized.
Stocks of strong Banks
It is a well-known fact that Banks benefit the most when interest rates break the glass barrier. They can legitimately expect higher returns when they lend money at higher rates, and they also get better returns on funds that they park in lucrative investments. So it makes sense to gather Bank stocks that ensure a better yield when interest rates are on a roll. They also serve to balance the losses that may result in other corporate investments.
Hard-Money lending options that generate higher returns
This is basically a loan that is secured by some tangible asset like your home or any other real estate. This kind of lending activity is common in the scenario where rates are rising, and there may be less chances of getting credit, but demand for capital is increasing exponentially. In such an activity there will be a premium on financing the public, and a bigger premium on applicants that come along with not-so-stable financial backgrounds, so it carries fair share of risk. If that kind of risk is unacceptable, you can try peer to peer lending, target specific private lending or leveraged loans to firms or individuals that are already carrying debt, but which can afford higher lending rates.
Dollar Cost Averaging (DCA) – continuing investments regardless of market volatility
In this method the investor invests a fixed sum in stocks, and this is repeated on a regular basis at specified intervals, say once or twice a month, regardless of the market situation. For portfolio managers that are not content with leveraging only financial securities, dollar cost averaging shows a way out in the “what to do, where to invest” dilemma. When prices are breathing low, the DCA is a good technique to shore up the investment portfolio and prevent stagnation. Ultimately, when the markets regain confidence, there will be more shares in the portfolio to reap higher returns.
Value Averaging – protecting portfolios against market fluctuation
This is yet another effective technique where a mathematical formula is leveraged by portfolio managers to ensure that the portfolio remains balanced regardless of the situation prevailing in a volatile market. It automatically promotes investment as prices fall and does the reverse when prices rise. To leverage this technique well, it pays to study and understand the changes in valuation of financial instruments over a longer duration.
Inverse Exchange-Traded Funds (ETFs)
These behave in a manner that is just the opposite of what ETFs do and they boost valuation whenever market prices are on a downward spin, and this is accomplished through derivative instruments that are the focus of investment. These instruments come into play when rising interest rates exert a downward pull on many other financial instruments. The IETF provides just the right hedge to contain risks and improve returns.
The last word
Interest Rates do fluctuate, and it is extremely difficult to predict when and how long rates remain on the higher curve. But ignoring a rate rise is an open invitation to portfolio instability. One should also be alert to opportunities for booking maximum profit in a situation where interest rates rise and currency appreciates, and buying stock and structuring laddered CDs are just a few of the tried and trusted routes that seldom fail the active investor.