Rising interest rates require revisiting your investment strategy

As published in the Minneapolis Star Tribune 4/15/2017.

It’s time to accept it. Rising U.S. interest rates will be the norm for the foreseeable future. Rising rates are nothing to fear but worth preparing for whether you are an investor or a borrower.

When the Federal Reserve hiked its benchmark federal funds rate on March 15 – the second increase in three months – it marked the beginning of a more predictable rate policy in the years ahead. Expect more hikes this year and two to three increases annually going forward.

For years, many speculated rising interest rates could choke America’s economic recovery. With the S&P 500 up 4 percent since the Fed’s December 2016 hike and within 2 percent of all-time highs, those concerns seem overblown. Rate increases typically coincide with a stronger economy.

Americans younger than 35 have never lived through a period of consistently rising interest rates. And those born after 1960 probably haven’t invested in this type of economic climate.

When rates rise, certain stock market sectors benefit more than others. Financials (think: banks, insurance, and investment firms) historically get the biggest boost. Loan defaults are less of a problem in a strong economy. These companies also earn a larger spread between the interest they pay savers and the rate they charge borrowers.

Those sectors offering larger dividend yields, like utilities and consumer staples, usually lag. Dividends are more highly valued in low-interest environments because conservative options like bonds earn such meager returns. As rates rise, low-risk investments become more viable to those investors in need of income. Companies paying big dividends also offer generally slower earnings growth.

Since bond prices have an inverse correlation to interest rates, bond funds will lose some of their total return as rates rise. This is a big change from the last 35 years. Individual bonds held to maturity avoid this problem and can be reinvested at more attractive yields as rates increase in a properly constructed bond ladder.

Mortgage rates for those purchasing new homes will increase slowly but steadily, which could act as a catalyst for the housing market as potential buyers look to lock in new loans before rates rise further. Every 0.25 percent bump to the federal funds rates results in $1.6 billion per year in extra finance charges for the 157 million Americans carrying credit card debt.

Now may be a good time to pay down your balance.

View the article here.