How to profit off today’s rising interest rates

Interest rates, which have been at all-time lows, have recently been on the rise. Because rates have such an impact on just about every facet of our financial lives, it’s crucial to understand how rising interest rates will impact them. So what are savers and investors to do as offensive or defensive moves?

First, it’s important to understand some basics.

Why Interest Rates Are Rising

There are signs that the U.S. economy is recovering, so the market sees an end in sight to the Federal Reserve’s massive bond buying programs, called “quantitative easing,” or QE. The Fed’s QE programs were put in place after the Great Recession in order to help stimulate the economy. They have helped to keep interest rates low.

Interest Rates, Bond Yields and Bond Prices

These relationships can seem a bit tricky, so here’s a diagram.

The relationships are:

• Rising inflation or the threat of rising inflation causes interest rates and bond yields to rise.
• Rising interest rates and bond yields cause bond prices to fall.
• Falling inflation or the anticipation of falling inflation causes interest rates and bond yields to fall.
• Falling interest rates and bond yields cause bond prices to rise.

It’s important to note that interest rates and inflation usually rise in tandem — but not always.

Rising Interest Rates: Savings Accounts and CDs

Fixed-income savers have had a tough time for a while. Bank savings accounts and certificates of deposit (CDs) have paid depositors very low interest for many years.

This group should benefit from rising rates. If interest rates continue to rise, then savings account holders and CD owners should see some light at the end of the tunnel.

Strategies for CD Buyers

When interest rates are rising, it’s usually a good idea to choose shorter-term CDs. This way your money doesn’t get tied up in a long-term CD that pays a low interest rate while rates rise.

Additionally, it’s a good idea to implement a CD ladder. That means buying CDs so they mature incrementally. For example, say you have $4,000 to invest in CDs. You can invest $1,000 in each of the following: a six-month CD, a one-year CD, an 18-month CD and a two-year CD. Then, as each matures, you can reinvest the money at current interest rates. If you invest the entire $4,000 in a two-year CD, and interest rates rise during that period, your CD’s interest rate will be lower than it could be.

While a small difference in interest rates doesn’t have a major effect over the short term, it can make a big difference over the intermediate and long term.

Rising Interest Rates: Bonds

Rising interest rates result in bond prices falling. Bonds have experienced a bull market (on the rise) for a long time. This will change if interest rates rise by a notable degree.

Potential Investment Strategies

Those heavily invested in bonds might want to diversify into other investments, such as CDs and Treasury Inflation-Protected Securities, or TIPS.

TIPS are like U.S. Treasury bills and bonds in that they are backed by the government. However, their principals rise with inflation or fall with deflation; and at maturity, the holder is paid the adjusted principal or original principal — whichever is greater. In other words, TIPS are a hedge against inflation. Inflation often, though not always, rises in tandem with interest rates.

Rising Interest Rates: Stocks

Rising interest rates can be a mixed bag for stock market investments. However, they’re usually more negative than positive.

The reason for the rise — that the economy is chugging along — can be a positive. When the economy is doing better, more people usually have more money to spend. However, it’s a double-edged sword. When interest rates rise, so do mortgage, car loan and credit card rates. Mortgages and car loans are two major expenses for most people.

On the corporate side, when interest rates rise, companies have to pay more in borrowing costs. The companies with high borrowing needs include so-called “capital-intensive industries,” which need a lot of money to upgrade their plants and equipment. Examples of which include utilities and auto manufacturers. Increased borrowing costs will usually result in less profit, and less profit is a negative for a company’s stock.

Potential Investment Strategies

When interest rates are rising, stock investors should favor companies that have less debt than their peers.

Additionally, they should focus on companies that make consumer products purchased by people who are less affected by rising mortgage, car and credit card rates ie., the more affluent.

Rising Interest Rates: Mortgages

This is a quick one: Those in the market for a mortgage should lock in a fixed mortgage rate as soon as possible! Don’t mess with adjustable rate mortgages (ARMs), as mortgage rates have almost nowhere to go but up. In fact, Dave Ramsey provides our readers with some compelling reasons why they should stick with a 15-year fixed rate mortgage specifically, rather than longer-term fixed home loans.