How to Invest In a Rising Interest Rate Environment

After many years of artificially keeping interest rates low, the Federal Reserve is in the process of steadily raising interest rates. There are many reasons for this, including a strong U.S. economy, low unemployment numbers, and the potential positive impact of the Trump tax cuts.

As investors, we find ourselves in a rising interest rate environment and many of us may not remember how to react. After all, just a few short weeks ago we experienced volatility in the market and many investors were scared.

After investing in 2017 where there was virtually no volatility, the sight of a market swinging thousands of points in a day shook the nerves of many.

And this is why it is important to understand the effects rising interest rates have on your investments. Gone are the days where you could create a portfolio and sit back and relax. In many cases, there are changes you need to make and opportunities out there to earn higher returns with less risk.

So let’s take a look at some important reminders so you can continue to grow your wealth in this changing market environment.

3 Tips For Investing In A Rising Interest Rate Environment

#1. Dust Off Your Investment Plan

The first step in handling a change in the investment environment is to dust off your invest plan and review it. A detailed investment plan should spell out your goals, risk tolerance and time horizon for your investments.

In other words, it is a roadmap for how and why you are investing. By having an investment plan, you can help yourself to not overreact and avoid emotional decisions when the markets change and become volatile.

If you had an investment plan when the market was swinging wildly the other week, you could have reviewed it and remembered why you are investing the way you are and would have only made changes if they were deemed necessary. You would not have given into your emotions since you would follow your plan.

If you don’t have an investment plan, you need to make creating one a priority. Having an investment plan is critical to the success of growing your wealth in the stock market. Here is an excellent guide to help you get started creating one.

#2. Understand How Bonds Work

The next tip for handling a rising interest rate environment is to remember, or in some cases learn, how bonds work. The key thing to understand is that bond yields and prices move in opposite directions.

This means when prices are rising, yields are falling. When yields are rising, prices are falling. Because yields have been rising and the Federal Reserve has a plan to continue to increase interest rates, yields should continue to rise and bond prices should fall.

This is important to understand for a few reasons. First, many investors mistakenly think they cannot lose money investing in bonds. The reality is that you can lose money investing in bonds.

Second, while you might be losing money in terms of the principal investment, the rising yield should offer you larger interest income. It may not completely offset the loss in principal, but you should see larger interest income as rates rise.

#3. Reassess Dividend Stock Holdings

The final tip is very important given the past 10 years. As interest rates hovered near zero, income investors struggled to find options for safe investments that could provide a steady stream of income for them.

Many ended up investing in high quality dividend stocks. Because so many investors put money into these stocks, the stock prices continued to rise higher and higher. Since interest rates remained near zero, there were no issues.

But now that interest rates are rising, there will be added volatility to the market. Many income investors will begin to sell out of their stock holdings and move back to the safer bonds since yields are rising.

This could cause added volatility into the market and cause dividend paying stocks specifically to fall in value.

Your Action Steps For The New Investing Environment

Here are the takeaways investors should understand as we enter this new investment environment of rising interest rates.

• Understand that volatility is back. Gone are the days when there were no wild swings in the market. Be prepared for wild daily rides, but know long term, everything will work out.
• Update your asset allocation. With bond yields rising, bond prices falling, and a volatile stock market, now is a good time to review your asset allocation and make sure you are diversified correctly. Taking on too much risk right now is going to cause you a lot of stress. Take the time to get your asset allocation right so you can sleep at night and stay invested in the market.
• Pay attention. With things changing right now, you need to pay attention to what is happening in the stock market. Doing so can ensure you take advantage of any opportunities that present themselves. But don’t get caught up emotionally in the action and make bad decisions.

Final Thoughts

Investing in a rising interest rate environment is something investors have not had to face in many years. While some might think this new era is a bad thing, the reality is that it is a good thing.

It shows that people are optimistic about the future growth of the economy and that the economy is doing well right now. This only leads to better things down the road.

So learn and get comfortable with where the market is and where it is headed and over the long term, you should do just fine.