Growth in the U.S. economy, markets and exchange traded funds (ETFs) has been aided by our exceptionally low interest rates. Yesterday, we were reminded that it’s becoming increasingly important to mind the rates and be prepared to act accordingly.
Yesterday, the Federal Reserved hiked what it charges banks for emergency loans. The move won’t affect corporate or consumer loans, but it’s a reminder that as the economic recovery advances, we’ll be seeing more rate increases.
The Federal Funds rate has been sitting around a low of between 0% and 0.25%, which has helped encourage borrowing and lower the cost of capital for individuals and businesses, comments Amanda B. Kish for The Motley Fool. As the Fed moves off these lows, you might find yourself needing to make adjustments to your portfolio. [Fed Hikes Rates.]
Bonds will be the first to take a hit. As rates rise, bonds become less lucrative since investors can buy newer ones with higher yields. One way to offset some interest-rate risk is by keeping bond allocations in short-term bond investments. Another option is to keep some money in inflation-protected securities (TIPs), which are indexed to inflation. More risk-tolerant investors may consider high-yield bonds – the likelihood of corporate defaults also drops as the economy improves. [Protect Against Big Deficits.]
- iShares Barclays 1-3 Year Treasury Bond (NYSEArca: SHY)
- iShares iBoxx $ High Yield Corporate Bond Fund (NYSEArca: HYG)
- SPDR Lehman High Yield Bond (NYSEArca: JNK)
- PIMCO Broad U.S. TIPS (NYSEArca: TIPZ)
- PIMCO 15+ Year U.S. TIPS (NYSEArca: LTPZ)
- PIMCO 1-5 Year U.S. TIPS (NYSEArca: STPZ)
- iShares Barclays TIPS Bond (NYSEArca: TIP)
- SPDR Barclays Capital TIPS (NYSEArca: IPE)
The Fed may find itself in the position of needing to raise rates while unemployment remains relatively high, which likely means that the stock market won’t react to the decision favorably. Higher rates affect how companies borrow money and how they conduct business. Dividend-producing stocks may be a good choice in the long-term. Interest rate hikes usually coincide with an improving economy and companies tend to dish out higher dividends as an economy improves. [How to Play a Dividend Comeback.]
- Wisdom Tree Dividend ex-Financial (NYSEArca: DTN)
- iShares Dow Jones Select Dividend Index (NYSEArca: DVY)
- PowerShares High Yield Dividend Achievers (NYSEArca: PEY)
- Vanguard Dividend Appreciation (NYSEArca: VIG)
For full disclosure, some of Tom Lydon’s clients own shares of SHY and TIP.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.