How to Profit from Rising Interest Rates

Benzinga explains how investors can adapt their strategy for a period of rising interest rates. 

In an era of skyrocketing inflation, the Federal Reserve has once again raised its policy interest rate — the 11th hike in just 17 months. As of Wednesday, July 26, 2023, the benchmark short-term rate stands at a two-decade high of 5.3%. 

While this move aims to cool down the overheating economy, it sends a ripple effect across various financial markets, nudging up the costs of mortgages, auto loans, credit cards and business borrowing. 

If you're an investor worried that rising interest rates will torpedo your portfolio, think again. A rising rate environment isn't just about challenges; it also presents opportunities.

Understanding the Relationship Between Interest Rates and Investing

The country's central bank, the Federal Reserve (Fed) uses interest rates as one of its main tools to control the U.S. economy. By manipulating these rates, it can either stimulate economic activity or cool down an overheating economy. Think of it as a lever it can push or pull to steer the economy towards a desirable long-term trajectory. 

In general, lowering interest rates generally encourages people and businesses to borrow and spend, which can help pull a sluggish economy out of a downturn. This effect occurred during the depths of the COVID-19 pandemic, which helped avert a recession. 

Raising interest rates can have the opposite effect, curbing spending and investment to control inflation. This transformation played out throughout 2022 and 2023, when inflation skyrocketed and remained persistent. 

When interest rates rise, the general tendency is for the stock market to face headwinds. In general, higher rates increase the cost of borrowing for companies, which can reduce corporate profits and, by extension, lower stock prices. 

However, not all sectors are impacted equally. Historically, sectors like utilities and real estate, which are capital-intensive and often rely on borrowing, can underperform in a rising-rate environment. 

Sectors such as financials typically benefit, as banks can charge more for loans compared to what they pay on deposits. Keep in mind that interest rates are just one of the many variables that move markets, so it's important not to over-emphasize their impact. 

Fixed-income instruments like bonds are perhaps more directly impacted by interest rate changes than any other asset class. When interest rates rise, bond prices usually fall, while bond yields rise. 

New bonds issued pay higher interest rates, making existing bonds with lower rates less attractive by comparison. Consequently, if you're holding long-term bonds in a rising interest rate environment, you could see the market value of those bonds decrease.

9 Best Ways to Invest When Interest Rates Are High

Contrary to popular belief, a high-interest-rate environment isn't a total financial wasteland; it's a shifting landscape that offers its own set of rewarding investment avenues. Here are nine of the best ways to invest when interest rates are high.

Short-Term Corporate Bonds

In a rising interest rate environment, consider moving away from long-term bonds in favor of short-term bonds with anywhere from one to three years in maturity. 

These bonds are less sensitive to interest rate changes and offer the flexibility to reinvest at higher rates when they mature. Corporate-issued short-term bonds tend to also pay higher yields, at the cost of greater credit risk. 

You can easily access short-term corporate bonds via an exchange-traded fund (ETF) like the Vanguard Short-Term Corporate Bond ETF (NASDAQ: VCSH), which currently pays a yield to maturity (YTM) of 5.5% as of July 31, 2023. 

Treasury Bills

For lower credit risk, albeit at the cost of lower yields, investors can buy Treasury bills, or T-bills, which are short-term debt securities issued by the U.S. government. They have maturities that range from a few weeks to a year.

Investors buy T-bills at a discount to their face value. When the bills mature, the government pays the face value. The difference between the purchase price and the face value is the investor's return.

In a rising interest rate environment, T-bills are attractive because they are low risk and have short maturities. This factor allows investors to reinvest more frequently at higher interest rates.

ETFs like the SPDR Bloomberg Barclays 1-3 Month T-Bill ETF (NYSEARCA: BIL) and the iShares 0-3 Month Treasury Bond ETF (NYSEARCA: SGOV) hold T-bills. 

Certificate of Deposit (CD)

A CD is a type of savings instrument offered by banks or credit unions that typically offers a fixed interest rate over a specified period of time, where your investment is locked up.

When you buy a CD, you deposit a lump sum for a fixed term, ranging from a few months to several years. In return, you receive a fixed interest rate over that period.

When interest rates are high, investors can use a CD to lock in an attractive, risk-free yield for a period. Unlike investments, CDs are also insured by the Federal government. 

Money Market Mutual Fund

A money market mutual fund is a type of fixed-income mutual fund that invests in high-quality, highly liquid securities such as T-bills, commercial paper and repurchase agreements.

While not entirely risk-free, money market ETFs are considered a very low-volatility option. They are designed to maintain a stable net asset value per price of $1.

When interest rates rise, the yields paid by money market funds tend to move upwards in lockstep, making them an attractive way to hold cash in a brokerage account. 

Inverse Bond ETF

Traders who don’t mind additional risk can look to profit from falling bond prices via an inverse bond ETF. These ETFs use derivatives like swaps to deliver the opposite return of a benchmark bond index daily.

For example, the Direxion Daily 20+ Year Treasury Bear 3x Shares ETF (NYSEARCA: TMV) attempts to deliver a daily return -3x, or three times inverse that of the ICE U.S. Treasury 20+ Year Bond Index.

These ETFs are advanced trading tools and not suitable for beginner investors, as they can be quite volatile, behave unpredictably and charge high fees. 

Interest Rate Hedge ETF

These ETFs are niche investments designed to directly hedge against, or profit from, rising interest rates. They usually use advanced fixed-income derivatives and quantitative strategies to achieve their objectives.

Examples include the Quadratic Interest Rate Volatility and Inflation Hedge ETF (NYSEARCA: IVOL) and the Simplify Interest Rate Hedge ETF (NYSEARCA: PFIX). As with inverse ETFs, these products are best suited for advanced investors with a high-risk tolerance. 

Floating Rate Bonds

Floating rate bonds, also known as floaters or variable rate notes, are unique debt securities with variable interest rates that adjust periodically. Unlike fixed-rate bonds, the interest payments you receive from these bonds can fluctuate based on the prevailing interest rate environment. 

The interest rate of a floating rate bond is typically tied to a benchmark like the Secured Overnight Financing Rate (SOFR). Periodically — often every 3, 6 or 12 months — the interest rate will reset according to the prevailing benchmark rate plus a fixed spread. This means that if the benchmark rate rises, the interest payment on the floating rate bond will increase accordingly and vice versa.

Floating rate bonds are designed for environments where interest rates are on the upswing. When rates rise, the yield on these bonds adjusts upwards, providing investors with higher interest income. This feature makes them particularly attractive in a high-interest-rate environment where fixed-rate bonds would lose value.

Examples of ETFs that hold floating-rate bonds include the WisdomTree Floating Rate Treasury Fund (NYSEARCA: USFR), the iShares Floating Rate Bond ETF (NYSEARCA: FLOT) and the SPDR Bloomberg Investment Grade Floating Rate ETF (NYSEARCA: FLRN). 

High-Yield Savings Account (HYSA)

Some banks and credit unions may offer an HYSA that pays a higher interest rate compared to a traditional savings account. Just like a regular savings account, you deposit money into a HYSA and earn interest over time. 

The main difference is the higher interest rate, which is often several times the national average for regular savings accounts. The account is federally insured up to $250,000, making it a virtually risk-free option for parking your cash.

As interest rates rise, banks often increase the interest rates on their high-yield savings accounts to attract more deposits. That means you could see the yield on your HYSA go up in a rising interest rate environment. Unlike CDs, you're able to withdraw your money at any time. 

Do Nothing and Stay the Course

Sometimes, the best action is inaction. This entails maintaining your existing mix of assets — typically a balanced portfolio of stocks, bonds and other investments — without making significant changes in response to market conditions, including rising interest rates.

Investors who choose this strategy are generally in it for the long haul. They rely on the principles of diversification and long-term growth, avoiding the temptation to react to short-term market fluctuations. By holding a variety of assets, they aim to mitigate risks and achieve more consistent returns over time.

While rising interest rates can affect the short-term performance of bonds and stocks, the impact tends to be less pronounced over long periods. Historical data suggests that diversified portfolios can withstand a variety of economic conditions and still offer positive returns. 

If you've designed your buy-and-hold portfolio for long-term growth, short-term rate changes may not significantly alter your overall trajectory.

Sectors That Benefit from Rising Interest Rates

Not all sectors are adversely affected by rising interest rates. In fact, certain sectors tend to perform better in a high-interest-rate environment. Understanding these sectors can help investors strategically allocate their assets when rates are on the rise. 

However, keep in mind that the performance of these sectors is also affected by variables outside of rising interest rates, so it's important to understand these as general observations and not strict rules of cause and effect. 

• Financials: This sector includes businesses like banks, insurance companies and investment funds. Financial institutions often benefit from rising interest rates because they can charge higher interest on loans compared to what they pay on deposits. This widens their net interest margin, increasing profitability. Essentially, they make more money on the spread between loan rates and deposit rates, making this sector attractive in a rising rate environment.
• Energy: The energy sector encompasses companies involved in oil, gas and alternative energy production. These companies stand to gain from rising interest rates often because such rates usually align with periods of inflation. Increased industrial and consumer activity boosts energy demand, often leading to higher energy prices, which in turn benefits the sector's bottom line.
• Consumer staples: Companies in this sector produce or sell essential goods like food and personal care items. Rising interest rates often coincide with a strong economy where consumers are more willing to spend, even on necessities. In inflationary environments, which often trigger rate hikes, these companies can also pass on higher costs to consumers, preserving their profit margins.

Invest Today with Benzinga’s Top Brokers

Investors looking to research and choose the best investments for a rising interest rate environment can use Benzinga to compare the available selections available on the market. Here is a list of brokers that support trading in various assets and offer research tools to help investors select the right one.

Navigating a Rising Interest Rate Environment

In a landscape where interest rates are on the upswing, investors might feel the urge to make sweeping changes to their portfolios. However, a rising rate environment doesn't necessarily signal impending doom; it offers both challenges and opportunities. 

Sectors like financials, energy and consumer staples often benefit from higher rates, offering investors lucrative avenues for capital allocation. Financial institutions increase their net interest margins, energy companies see demand and prices rise and consumer staples firms capitalize on a robust economy.

Meanwhile, individual investors have a variety of tools at their disposal, from high-yield savings accounts to floating rate bonds, which not only help insulate from rate hikes but also offer the potential for increased returns. 

And for those who prefer a hands-off approach, sticking to a diversified, long-term portfolio can offer its own rewards, effectively weathering the impacts of fluctuating rates over the long run.

While rising interest rates can unsettle the market in the short term, they also open new pathways for potential profit. The key lies in understanding these shifts and adapting your investment strategy accordingly.

Frequently Asked Questions