Everybody has an opinion about where the economy is headed, but at least one variable has been pinned down—the Federal Reserve will continue to raise interest rates into the foreseeable future. The Fed recently announced that it is lifting its federal funds’ target rate, a benchmark for many consumer and business loans, by a quarter-point to a range of two to 2.25 percent. It also stuck with its previous forecast for three more rate increases in 2019.
This is a gamechanger for investors. Over the last 12 years, investors grew used to rock-bottom interest rates and cheap money. Those days are fading fast. Smart investors are now starting to tailor their investments based upon the new reality of rising interest rates.
Investing in a rising-interest-rate environment is difficult, as it acts as a suppressant on all asset prices. So sometimes it is best to play defense and focus on assets less sensitive to rising rates.
Companies have been taking advantage of the historically low-interest-rate environment by issuing long-term bonds at favorable rates while retiring shorter-term bonds. The supply of these long-term bonds has been met by demand from investors starving for an adequate yield. Meanwhile, as the short-term bonds mature, investors will get their capital back and will be able to reinvest in a higher-interest-rate environment.
Financial firms tend to do well during a rising-interest-rate market, especially as the long end of the yield curve outpaces the short-term end of the yield curve and the spread between those two grows.
Supplementally, long-term interest rates typically rise because there is an underlying belief that economic growth is occurring in the near-future. For the last couple of years, the spread between short-term and long-term rates has been tight or narrow.
Financial firms like banks make money when they are able to borrow in the short term at lower rates and then lend at the long-term, higher rates. They make money on the difference in yields. “Net Interest Income” is one of the primary fundamental metrics that all financial analysts study when reviewing a bank.
Many investors are already scaling back bond holdings. Many retirees/pre-retirees approach retirement by becoming a bit more cautious with their investments so they increase bond holdings. With rate hikes affecting bond portfolios negatively (as rates go up, bond performance falls), this could adversely affect what many thought to be safe returns. Rising interest rates could ensure some loss to many bond portfolios.
The bottom line is that now is the time to meet with your financial planner and discuss how your portfolio should adapt to the new reality of rising interest rates. Remember, there are still plenty of worthwhile investments to be made, but for you to gain the maximum return, they probably won’t be the same investments that have been golden for the last few years. iBi
Stash J. Graham is managing director of Graham Capital Wealth Management. For more information, visit grahamcapitalwealth.com.