How Investors Can Take Advantage of Rising Interest Rates

While all eyes are on the Fed as it plans its next move, there are ways investors can take advantage of rising interest rates in the interim. 

The Federal Reserve increased interest rates seven times in 2022 in an effort to cool the economy and control sky-high inflation. In fact, the federal funds rate stood at its highest level in 15 years following the Fed’s December 2022 meeting.

The Fed’s latest rate hike cycle is a sharp departure from the central bank’s near-zero interest rate policy during the Covid-19 pandemic, and markets have reacted accordingly. Specifically, 2022 was the worst year on record for bonds, and the U.S. stock market had its worst year since 2008.

Indeed, a rising rate environment can present a variety of challenges for consumers and investors alike. Yet challenges often create opportunities. Fortunately, there are ways for long-term investors to take advantage of rising interest rates.

Consider the following tips to take advantage of rising interest rates:

#1: Stay diversified but emphasize sectors that tend to perform better in a rising rate environment.

In general, equity markets tend to react negatively to rising interest rates as they often create economic headwinds that slow the pace of growth. At the same time, demand for stocks tends to decline as interest rates increase since investors can earn a higher return on their cash elsewhere while taking on less risk.

Yet that doesn’t mean long-term investors should abandon their equity investments altogether. Historically, stocks are one of the only asset classes to consistently outpace inflation over the long run. Meaning, investing in a diversified portfolio of stocks is necessary for long-term investors to maintain their purchasing power over time.

In addition, some sectors of the market tend to perform better than others when rates increase. These sectors may offer investors an opportunity to take advantage of rising interest rates in the near-term.

For example, financial services companies tend to profit from higher interest rates as banks and other financial institutions increase the cost of borrowing. Meanwhile, communication services, healthcare, and utilities companies also tend to benefit from investors shifting their capital towards historically stabler sectors.

Of course, there may be other factors at play that make these sectors less attractive in a rising rate environment. Ultimately, maintaining a diversified portfolio can help you capitalize on market opportunities and preserve your financial resources over time.

#2: Invest in bonds to take advantage of rising interest rates.

Since bond prices tend to fall as interest rates rise, investing in bonds in a rising rate environment may seem counterintuitive. However, not all bonds are equally sensitive to interest rates.

A bond’s sensitivity to interest rates is measured by its duration. Put simply, the shorter a bond’s duration, the less sensitive it is to changes in interest rates and vice versa. In addition, higher yielding and lower quality bonds tend to be less sensitive to interest rate changes.

If your goal is simply to minimize interest rate risk, you may want to consider shifting your investment portfolio towards shorter duration bonds. However, there may also be opportunities to make money in bonds as interest rates rise.

For example, corporate and municipal bonds may be attractive alternatives to Treasuries, which tend to be more sensitive to changes in the federal funds rate. High yield and floating rate bonds may also be worth considering; however, investing in these types of bonds can introduce different risks to your portfolio.

Lastly, long-term investors may not need to make any changes to your fixed income portfolio. As your bond holdings mature, you can take advantage of rising interest rates by reinvesting the proceeds at higher yields.

Keep in mind that bond markets are complex and often difficult for the average investor to navigate. To avoid missteps, consider hiring an investment advisor or wealth manager, who can help you develop an investment strategy that meets your needs.

#3: Look for opportunities to maximize your return on cash.

Another way to take advantage of rising interest rates is to maximize your return on cash. Higher interest rates may provide a welcome boost to your savings accounts, which can be helpful if you’re concerned about near-term market volatility or experience an unexpected financial setback.

Currently, savers have a variety of options to earn a higher rate of return on their cash. For example, yields on high yield savings accounts are currently around 3-4%, compared to 0.23% for a traditional savings account. On average, high yield savings accounts earn roughly 17 times more in interest than a traditional savings account.

In addition, many CDs currently offer interest rates above 4%, which is higher than the return on most high yield savings accounts. However, you must keep your money in a CD for a specific period—usually six months or longer—to earn interest, which can make them less attractive if you need quick access to your funds.

Lastly, Series I Savings Bonds may be an effective way to take advantage of high inflation and rising interest rates.

A Series I Savings Bond (I Bond) is a security that earns interest based on both a fixed rate and a rate that is set twice a year based on inflation. The bond earns interest for a period of 30 years or until you cash it in, whichever comes first.

Since I Bond rates are tied to inflation, they become more attractive as inflation rises. Currently, I Bonds are paying an interest rate of 6.89% if you purchase them from now until April 30, 2023.

It’s important to note that there are a variety of caveats involved with buying Series I Savings Bonds. If you’re considering putting your cash into I Bonds, make sure you understand the potential pros and cons first.

#4: Use market volatility to take advantage of tax planning opportunities.

One of the downsides of rising interest rates can be increased market volatility. Indeed, 2022 was a rough year for both stocks and bonds, and volatility has continued into 2023.

While fluctuating account balances may cause stress, they can also provide valuable tax planning opportunities. For example, the IRS allows investors to offset realized capital gains with realized losses from other investments in the same tax year—a strategy known as tax-loss harvesting. That means if you have substantial losses, you may be able to completely offset your gains and potentially reduce your taxable income for the year.

In addition, market volatility may have caused your asset allocation to drift from its original targets over the past year. Rebalancing when stock and bond prices are depressed may provide an opportunity to upgrade your portfolio at a discount and/or minimize the potential tax consequences in a non-qualified account.

Lastly, you may want to consider a Roth conversion when the market is down. Since account values typically decline in a negative market environment, so does the amount on which you pay taxes when converting to a Roth. Meanwhile, there’s greater potential for future appreciation and withdrawals that tax-free.

An Experienced Financial Advisor Can Help You Take Advantage of Rising Interest Rates

The last 12 months have been challenging for many long-term investors. However, it’s important to remember that markets tend to be cyclical. In time, inflation and interest rates will return to more normal levels, and markets will eventually calm down.

In the meantime, there are many opportunities for investors to take advantage of rising interest rates. If you’re looking for additional guidance, consider working with an experienced financial advisor, who can help you develop a long-term financial plan that keeps you on track towards your goals in any market environment.

SageMint Wealth specializes in financial and estate planning for high-net-worth individuals, families, and business owners. We have a passion for supporting women, the LGBTQ+ community, and individuals in the technology space. If you’d like to learn more about how a fiduciary financial planner can help you manage your wealth, please contact us. We’d love to hear from you.