The Federal Reserveâ€™s decision to raise interest rates last week has sent ripples through the global economy. But you may be feeling the impact a bit closer to home, if youâ€™ve looked at your portfolio. Fortunately, there are a few things you can do to protect your investments. Read on, particularly if youâ€™re heavily invested in bonds.
Following the Federal Reserve’s decision last week, interest rates are expected to continue a gradual upward creep in the months to come. The Fed had been relying on a policy of low rates to rehabilitate the economy after the Great Recession. But policy makers indicate they’ve seen signs of recovery, possibly marking the end of low rates. That’s a problem for the unprepared, as historically rising interest rates have spelled trouble for portfolios.
Luckily, you’re reading this article and therefore, not among the unprepared. You can act now to limit the damage.
Here’s what you need to know, when it comes to guarding your portfolio:
ARE YOU A BOND-HOLDER?
Now is the time to review your bond holdings. Rising interest rates bring new bonds that pay higher rates. That means if you’re an investor with bond holdings, it’s going to get harder to sell them, since new, higher-paying bonds are available.
Estimate your risk by looking at your bonds’ duration — the approximate volatility (up and down price movement) of a bond or bond portfolio in relation to changes in interest rates. For example, a bond with a duration of 10 means that a 1 percentage point change, up or down, would raise or lower the value of the bond by about 10 percent. You read that right: If you own a bond fund or bond exchange traded fund (ETF) with underlying holdings that are 10, 15, 20 years or more in duration, you could lose 10, 15, or even 20 percent in value for every 1 percentage point rise in rates. If you own bonds with durations longer than two or three years, it might be prudent to exchange them for bonds with shorter duration If you own an indidual bond and don’t plan on selling it anytime soon, you might consider holding it to maturity, but prepare yourself for a rough ride until then.
If your close to retirement, it’s generally not a good idea to load up on bonds under these circumstances. Traditionally, the thinking has been that you need more stability in your portfolio to avoid potentially large losses from a steep stock market decline just before or during retirement. A long-cited rule of thumb holds that people should have a percentage of stocks in their portfolios equal to 100 minus their age, with the balance in bonds or other relatively safe assets. For example, a 60-year-old would have 60 percent of their assets in bonds and 40 percent in stocks. This formulaic approache may have worked well decades ago, but now that the nearly 30-year bull market in bonds may be coming to a halt, it may not work for many investors.
It’s time to think about risk reduction if you’re nearing retirement. The best way to do that is to seek alternatives to bonds. Your options: floating-rate funds; Treasury Inflation-Protected Securities (TIPS), which have an interest rate pegged to inflation; or short-term certificates of deposit with maturities structured to overlap (known as a ladder).
BUYING A HOME?
Now may be the time to act if you’re planning to finance a new or vacation home. You might want to accelerate your purchase to avoid higher interest costs. Buying after a series of rate increases can bring regrets that can be calculated in real dollars.
ATTACK YOUR STUDENT LOANS
If you’re still paying off student loans, particularly if they’re adjustable rate loans, now may be a good time to review your payment options. Unfortunately, many health professionals are still paying down debt, given the protracted nature of their professional educations. Rising rates mean you should probably try to get these loans paid off sooner rather than later. It’s a good peace-of-mind builder regardless of what rates do. If you have adjustable rate loans, consider refinancing now to lock in today’s low rates.
WHAT ABOUT STOCKS?
Rising interest rates can also affect your stock holdings. The initial phase of rising rates can be good for the stock market, as this generally indicate an improving economy, but rising rates are not good for stocks long-term — particularly when increases are sudden or in rapid succession. But if you know what you’re doing or get the right advice, you can take advantage of interest rate changes by rotating your holdings into sectors that tend to do well in a rising rate environment. These sectors include energy, financials, consumer discretionary, technology, industrials and materials. As the market begins to cool, after higher rates begin to take their toll, you may want to shift into more defensive sectors such as utilities, telecom, consumer staples, real estate investment trusts (REITs) and healthcare.
By monitoring interest rate trends, you can be prepared to adjust your portfolio that can help keep rising rates from reducing the size of your nest egg.
Eric C. Jansen, ChFC®, is the founder, president and chief investment officer of Westborough, Mass.-based AspenCross Wealth Management (AWM), which provides fee-only retirement-income planning and investment-management services for high net worth clients nationwide.
The information presented is not intended as financial advice, and you are encouraged to seek such advice from your financial advisor. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Keep in mind investing involves risk. The value of your investment will fluctuate over time, and you may gain or lose money. Diversification/Asset Allocation does not ensure a profit or guarantee against loss. Registered Representative/Securities and Investment Advisory Services offered through Signator Investors, Inc. Member FINRA, SIPC, a Registered Investment Advisor. AWM is independent of Signator. One Technology Drive, Westborough, MA 01581.