Discover how rising interest rates may effect the investments in your portfolio. And learn about investment strategies that may help minimize the risks and maximize the potential for growth.
As an investor, it's important to know whether interest rates are rising or falling. Why? Changes in interest rates impact the performance of stocks and bonds. Which way rates are headed, along with your goals and risk tolerance, may influence how you diversify your portfolio.
Let's take a look at how rising interest rates may impact your investments and strategies to help sustain your portfolio in this type of economic climate.
Generally, bond prices and interest rates move in opposite directions—when interest rates rise, bond prices tend to decline. Think of it this way. All other things being equal, given the choice of a $1,000 bond that pays 2% interest or one that pays 3%, which would you choose? The higher interest rate can make the lower-yielding bond less appealing to investors, which causes the price to drop.
Not all bonds react the same way to interest rate changes. Some are more sensitive depending on the type of bond and its maturity. Corporate bonds typically have higher coupon (interest) rates, which generally make them less sensitive than U.S. Treasuries. Bonds with shorter durations (maturities) are usually less affected by rate changes as well.
One way to potentially help minimize the risks of rising interest rates is to create a bond ladder, which involves having multiple bonds with different maturity dates. As the bonds mature, you can purchase new ones with higher yields, assuming rates are still rising. You may also want to consider diversified bond mutual funds or exchange-traded funds (ETFs).
Stock prices and interest rates also tend to move in opposite directions, but for different reasons. Higher interest rates make it more expensive to borrow money. A business that doesn't want to pay the higher cost for a loan may delay or scale back projects. This in turn may slow the company's growth and affect its earnings. A business's stock price generally drops when earnings decline. Rising rates typically also lead to a stronger dollar, which may put additional pressure on the stock prices of multinational companies because it becomes more expensive to do business in some countries.
Like bonds, not all stocks react the same way to rate hikes. In fact, some sectors historically perform well during periods of rising interest rates. For example, banks typically have stronger earnings because they can charge more for their services. Of course, past performance is not an indicator of future results.
As you review your portfolio, check to see which sectors your stocks are in. It could be a good idea to avoid being heavily invested in one particular area of the market. You may also want to consider dividend-paying stocks, which historically have performed well when rates rise, diversified stock mutual funds, or ETFs.
Not everyone has the time, desire, or resources to monitor interest rates and actively manage their investments. If this sounds familiar, you may want to consider a managed portfolio. With portfolio management, professional money managers recommend a mix of investments based on your goals and risk tolerance and monitor your account on an ongoing basis.
Financial markets and interest rates move in cycles, and no one knows for certain how long an upward or downward trend may last. A well-diversified portfolio may help you pursue your financial goals whatever the economic climate.
for thinkMoney ®
Financial Communications Society 2016
for Ticker Tape
Content Marketing Awards 2016
Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
Carefully consider the investment objectives, risks, charges and expenses before investing. A prospectus, obtained by calling 800-669-3900, contains this and other important information about an investment company. Read carefully before investing.
All investments involve risk, including loss of principal. Past performance does not guarantee future results. There is no assurance that the investment process will consistently lead to successful investing.
Investments in fixed income products are subject to liquidity (or market) risk, interest rate risk (bonds ordinarily decline in price when interest rates rise and rise in price when interest rates fall), financial (or credit) risk, inflation (or purchasing power) risk and special tax liabilities. May be worth less than the original cost upon redemption.
Mutual funds are subject to market, exchange rate, political, credit, interest rate and prepayment risks, which vary depending on the type of mutual fund. Fund purchases may be subject to investment minimums, eligibility, and other restrictions, as well as charges and expenses. Certain money market funds may impose liquidity fees and redemption gates in certain circumstances.
ETFs can entail risks similar to direct stock ownership, including market, sector, or industry risks. Some ETFs may involve international risk, currency risk, commodity risk, and interest rate risk. Trading prices may not reflect the net asset value of the underlying securities. Commission fees typically apply.
Asset allocation and diversification do not eliminate the risk of experiencing investment losses.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC, and a subsidiary of TD Ameritrade Holding Corporation. TD Ameritrade Holding Corporation is a wholly owned subsidiary of the Charles Schwab Corporation. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2020 Charles Schwab & Co., Inc. Member SIPC.