With inflation rates at their highest in 40 years, the fed is finally raising interest rates. Many retail investors are worried about the depreciation of their assets. Does this have many people wondering what types of investments are safe stores of value when interest rates are rising?
First things first-some investments are, if not neutral, actually aided by rising interest rates. This post will explore those investments that are resistant to or even made stronger by-rising interest rates.
However, before we dig into those investment ideas, let’s get some investment basics out of the way.
What You Need To Ask Yourself Before Investing (In Anything)
Though throwing money at a new investment idea might seem tempting, you need to make sure you are in a good financial position to do so. That’s why you need to consider the following questions before making any serious investments:
1. How Much Can I Afford To Invest?
You need to consider how much capital you can invest. As a general rule, you should never invest more than you can afford. However, some investment options have a minimum amount, so you’ll need to build up the capital to invest in some options.
2. What Is My Expected Return on Investment (ROI)?
Different asset classes have various annual yields and come with their own risks. When planning to invest, you should develop an understanding of the average ROI of the asset class you are investing in so that you can project gains. Usually, the higher the return, the higher the risk. This brings us to our next question.
3. How many risks Can I Withstand?
If you can stomach market volatility, then you may be comfortable with taking on more risk. Alternatively, you may be risk-averse and want to invest in secure, stable assets that have slower growth. The amount of risk you can tolerate depends on many factors including your age, your wealth, and your personality.
4. What Is My Time Horizen (How Long Am I Holding?)
A time horizon is how long you plan to hold onto your investment. Generally, the longer you wait, the greater the return will be. Depending on your investment goals, you might need a shorter time horizon because you wish to grow your portfolio quickly, or you might want a longer time horizon because you are investing for retirement.
Now that you have considered these important investment questions, we can dig into what investment ideas are the best for rising interest rates.
Best Investments For Rising Interest Rates
Though the actual effects of rising interest rates are complicated, broadly speaking, when the Federal Reserve hikes interest rates, it means that holding debt becomes more expensive. Many businesses run on credit and acquire upfront capital through loans.
Because higher interest rates make holding debt more expensive, many business projects, construction projects, and other enterprises that depend on loans or credit stall out or get cut entirely. This can slow economic growth when managed poorly.
However, some businesses actually benefit from a hike in interest rates. You’ll want to position your portfolio towards these types of businesses during times when interest rates are higher.
1. Invest in the Big Banks
Though borrowers tend to suffer when interest rates are raised, the lenders usually benefit from interest rate hikes. You can invest in big bank stocks—Wells Fargo, JP Morgan, and the like.
Not only are these companies likely to benefit from the fact that they are major lenders, but these companies are proven, stable financial powerhouses that will likely withstand economic downturns.
2. Invest in Commercial or Residential Real Estate Companies
Interest rate hikes will directly affect the financing of real estate acquisitions because loans are often required to afford to purchase a property. However, certain real estate-related companies can benefit-or at least withstand-interest rate hikes.
Generally, real estate appreciates in value over time and is considered to be a good hedge against inflation. There are several ways to invest in the real estate market:
3. Real Estate Investment Trusts (REITs) and REIT ETFs
REITs are companies that specialize in purchasing, developing, and managing real estate properties. Their focus can be very narrow-only focusing on warehouse properties, grocery store properties, or highrise apartments-or very broad, investing in all sorts of property types.
Because they are publicly traded companies, you can invest in them on the stock market like you would any other stock.
REIT ETFs are exchange-traded funds that invest in REITs. The difference can get a bit muddled, but the best way to understand it is to say this:
REITs are companies that purchase, develop and manage properties, and REIT ETFs are investment funds that invest in REITs. As an investor, the difference is negligible as both options are available on the stock market. It’s just that one option involves directly investing in a single company (REIT), and the other is investing in a fund that invests in many different REITs (REIT ETF).
4. Real Estate Private Equity Firms
However, if you prefer to be more hands-on with your investments and you have more capital to spare, you may consider investing in a private equity firm. Private equity firms are privately traded companies (not available on the stock market) that have higher minimum investments and are usually open to accredited investors only. These companies specialize in residential or commercial real estate investments and tend to be able to weather interest rate hikes fairly well.
5. Be Wary of Investing in Commodities
Commodities are materials and products that are fungible-ie, interchangeable with materials of the same type-and priced not according to who produced them or where they came from. The price of an ounce of gold is the same whether it came from a hole in the ground in Georgia or was stored in a bank in France.
Common examples of commodities include barrels of oil, wheat, and gold. These products are generally considered excellent hedges against inflation because they will always be in demand. However, their price is inversely correlated with interest rates. Generally, when interest rates are low, the price of commodities is high and vice versa.
What Investment Option is Right For You?
So, what investment option do you think is best when interest rates rise? As always, you should never invest more than you can afford to lose. Remember that there are always risks involved when investing in anything!
Roni Davis is a commercial real estate investor, blogger, and legal assistant operating out of the greater Philadelphia area.