Many investors know that interest rates have a big impact on their debt. After all, when interest rates rise, the cost of borrowing goes up. But did you know that rates can also affect your investments? Although many investors and analysts focus on low interest rates, rising interest rates change the marketplace landscape for businesses and individual investors. Here's how investors can profit from rising interest rates.
Key Takeaways
- Interest rates should be a factor that investors should consider when crafting or readjusting their portfolios.
- Investing in rising interest rates can be done by investing in banks and brokerage firms, tech and healthcare stocks, and companies with large cash balances.
- You can capitalize on higher rates by purchasing real estate and selling off unneeded assets.
- Short-term and floating-rate bonds are also suitable investments during rising rates as they reduce portfolio volatility.
- Hedge your bets by investing in inflation-proof investments and instruments with credit-based yields.
1. Invest in Banks and Brokerage Firms
Banks and brokerage firms earn money from interest. This means they can earn more when rates are higher, as credit isn't as readily available during these times. As such, consumers have to pay more to borrow. When the Fed has raised interest rates in the past, financial services firms like banks and brokerages have seen an improvement in interest income and operating profit margins.
On the other hand, borrowers tend to have more money in their pockets when interest rates are low. This means they often make larger purchases and borrow more during this time. As such, banks can make money off of the interest they earn in larger volumes. Even when rates are low, banks remain profitable because of the fees, commissions, and service charges they collect from their clients.
2. Invest in Cash-Rich Companies
Cash-rich companies benefit from rising rates because they earn more on their cash reserves. Investors can look for companies with low debt-to-equity (D/E) ratios or companies with large amounts of cash. Large, mature companies that hoard cash are also a great opportunity, such as Apple (AAPL). which had $28.4 billion in cash at the end of its second fiscal quarter of 2023.
A large and successful business like Apple can afford to hold significant amounts of cash. A smaller and less mature business that hoards cash should be avoided by risk-averse investors as it should be reinvesting in itself for growth.
3. Buy When Rates Are Low
Individuals or businesses planning on making major purchases or capital expenditures viewed as investments—like property or revenue-generating assets—should consider buying when they can lock in low long-term rates.
Purchases made before interest rates rise significantly can result in substantial savings in financing charges and overall long-term costs. Of course, you'll need to anticipate rising interest rates by monitoring the Federal Reserve's actions and economic conditions.
4. Invest in Technology and Health Care
Many investors favor dividend-paying companies because they share a portion of their earnings with shareholders. But if you're looking for a form of long-term growth with interest rates in mind, you may want to look elsewhere.
Mature companies in the technology and healthcare sectors tend to hold on to greater profits as retained earnings to reinvest in growth opportunities rather than paying them out in the form of dividends.
5. Embrace Short-Term or Floating Rate Bonds
Diversifying your portfolio is important during times of uncertainty. This includes finding new sources of income, especially when interest rates rise and inflation threatens the economy.
Bond investors (and any other investor, for that matter) can decrease the volatility in their portfolios during rising-rate environments by moving to or investing in bonds with short-term maturity dates or purchasing bonds with coupon rates that float in concert with the market rate.
Just remember that fixed-income vehicles aren't the only types of investments that you should consider. Having a strategy that encompasses a multi-asset approach can certainly help curb market risks and ensure a better return on investment (ROI).
Investing with portfolio managers who have a flexible approach can help you preserve your capital. These professionals can change sector weightings and duration exposures per market and interest rate swings.
6. Invest in Payroll Processing Companies
Payroll processors generally maintain large cash balances for customers in the periods between paychecks, which is when the money is distributed to their employees as payroll. These firms should see improved interest revenues when interest rates rise.
Some of the most common names in this industry include:
- Paychex (PAYX)
- Automatic Data Processing (ADP)
- Paylocity (PCTY)
7. Sell Assets
Individuals or businesses with unneeded property or other assets may be able to profit by selling these assets before rates begin to rise—again, this requires anticipating rate hikes. Buyers are more likely to make a purchase when they can still lock in low, long-term rates from their lenders, so they may be willing to pay premiums to acquire needed assets before rates begin going up.
8. Lock in Long-Term Supply Contracts
Rising rates don't just mean higher profits for those who sell their products and services to consumers. They also mean rising prices as well.
Just as consumers pay more in interest when they borrow from banks and other lenders, businesses also have to consider what higher rates mean for their bottom lines. Companies that can lock in long-term contracts with suppliers may enjoy better margins by avoiding increased prices for as long as possible.
9. Buy or Invest in Real Estate
Real estate prices tend to rise with and often even outpace interest rates. Buying real estate or investing in real estate investment trusts (REITs) is another way to realize profits from a rising rate environment.
Rising interest rates may sound bad for those who need to take out a loan or buy something on credit, but investors can profit by planning ahead and purchasing the right types of investments.
Inflation Hedge
As noted above, inflation has a big impact on investments. Central banks are more likely to keep interest rates low when inflation isn't as rampant. But rising inflation means higher prices, which leads to higher interest rates. Investors should, therefore, find a way to hedge the inflation risks. But how do you do it?
The best way to do so is to find investments better equipped to deal with the shocks of high or rising interest rates. These vehicles include:
- Treasury Inflation-Protected Securities (TIPS)
- Commodities
- REITs
You can also hedge your bets against inflation by investing in the equity market. U.S. equities provide investors with safety because of the favorable economic conditions in the country. International equities can also benefit investors because of fairly attractive valuations in these markets. You can also look for security in companies that can grow their dividends and have a good influence on pricing in the market.
Credit-Based Yield
Investors have traditionally been able to offset changes in interest rates by investing in certain fixed-income vehicles that provide a hedge against lower prices. This was done through things like government debt. But, their low yields can force investors to look elsewhere for greater income. That's where credit-based yields come into play.
The following are some of the key places you can look to to maximize your returns and help you benefit from changing interest rate environments:
- Debt with high yields, which operate just like REITs and have high yield fundamentals
- Debt from private sources, such as first-lien loans, which are commonly used to finance and buyouts, among other things
- Debt from emerging market economies
Are Bonds Good Investments When Interest Rates Rise?
Bond yields have an inverse relationship with interest rates. When rates rise, bond yields tend to fall and vice versa. Those with longer-term maturity dates tend to lock in rising interest rates for more time. But short- to mid-term bonds tend to do better in this kind of environment, so how interest rates affect yields depends on the type of bond you hold.
Do High Interest Rates Attract Investments?
Yes, higher interest rates tend to attract more foreign investment. That's because rising rates increase the value and demand for their own currency. On the flip side, a low-interest-rate environment often keeps these investors away because the value of their own currency can decrease.
What Happens to High Yield Bonds When Interest Rates Rise?
Bond yields have an inverse relationship with interest rates, so when rates drop, yields rise. When rates rise, bond yields drop. Having said that, even high-yield bonds are affected. Keep in mind, though, that these investments often come with a higher payout, and bondholders are paid out before shareholders if the issuing companies go under.
The Bottom Line
As an investor, there are several factors that you should consider when you're developing your investment strategy. Although they may not seem as important, interest rates should be one of those considerations. Not only do they affect the cost of borrowing, but they also have a big impact on how your investments perform. Using the tips above, investing with interest rates in mind can help increase your return on investment.
The comments, opinions, and analyses expressed on Investopedia are for informational purposes online. Read ourwarranty and liability disclaimerfor more info. As of the date this article was written, the author does not own any of the instruments discussed.
