What interest rate hikes mean for your portfolio
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Interest rates are rising, here’s what you should do
Banks, investors and brokerage firms have been nonstop trying to predict exactly how many times the Fed will raise interest rates. Nobody knows for certain when and by how much. But some are saying there will be 3 hikes for a total of less than 1%, others are saying there will be more than 5 hikes for a total of around 2%, and potentially even more in 2023.
The truth is, everything is up in the air. But what we do know is that interest rates are rising. And as investors, we can’t ignore it.
So what’s the deal?
When interest rates start rising, it’s typically a response to a booming economy. Some compare hiking interest rates to “tapping the brakes” and slowing down a little bit. The problem with this is just how much should you “tap the brakes”?
A rise in interest rates stops the economy from expanding too quickly or significantly impacting the Consumer Price Index (CPI) - which is the weighted average price of a basket of common household goods and services.
The opposite is also true. The Fed can reduce interest rates in an effort to stop the economy from shrinking too much. But enough with the economics (yawn).
How do rising interest rates affect your investments?
If you own bonds, this next part is for you.
(Disclaimer: I don’t own bonds)
When interest rates rise, bond prices fall. When interest rates fall, bond prices rise. The price of a bond has an inverse relationship with interest rates.
If you don’t own bonds (like me) the above means absolutely nothing to you. But hold on... because interest rates still affect the stock market, just in a slightly different way.
You probably hear the word “diversification” all the time. And rightfully so, diversification is important. Especially in a market like this, because certain sectors will respond differently to interest rate hikes.
Essentially what happens is that when the Fed raises interest rates, money becomes more expensive to borrow, making it harder to pay off debt. Loans and credit cards also become more expensive along with it.
About 25% of people in Canada and the U.S. are completely debt-free. This means the other 75% are struggling with having to pay higher interest rates on their loans, credit cards, etc. and therefore have less disposable income to spend on consumer goods.
Like anything in the economy, this creates a domino effect. When consumers spend less money, businesses make less money. When businesses make less money, it affects their stock price.
Side note: understanding economics is fun because you can make logical predictions about which direction the market may move in the near future. If you have some extra time this week, watch a youtube video on the basics of economics and how it affects the stock market. It’s quite interesting (or maybe I’m just a nerd)
With that being said, there are certain sectors that benefit from rising interest rates. And it’s your job as an investor to diversify your portfolio so that you hold stocks in these sectors. Cyclical industries like financial institutions, industrials and energy tend to perform well when interest rates rise.
Nothing is worse right now than being the all-your-eggs-in-one-basket tech bro investor. That guy is running for the fences and has probably not gotten a single hour of sleep in the last 2 weeks.
From now on, every time you hear the word “rising interest rates” I want you to associate it with RUST.
Pair the two together like they’re joint at the hip.
RUST stands for:
R - real estate investment trusts
U - utilities
S - staples (consumer staples)
T - telecommunications
Take a look at the 1-year sector performance graph below (source: finviz). The numbers don’t lie.
Final notes
You may be wondering what you should do now to prepare for these future interest rate hikes. And hopefully the above gave you some direction. But I’ll leave you with this final note:
Keep doing what you’ve always been doing. Diversify your investments, buy index fund ETFs, own some crypto, buy disruptive technology companies, own blue-chip stocks in mature industries. Create hedges by owning companies from all different baskets. Where you choose to allocate the bulk of your funds is your own choice, but judging from past performance RUST may be your best bet.
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Money Mastermind - the “Money Bible”. Myself and 29 other expert creators teamed up to create the most all-inclusive 280-page finance book on the market. Over 100 topics about money including real estate, crypto, budgeting, dividend stocks, online business, and more.
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Hipster Budget Guide - having trouble saving money? Learning how to budget is your solution. This book will show you ways to save money you never even thought of. Worth every penny.
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