The Risk of Rising Interest Rates

December 29, 2020

Interest rates remain near all-time lows. Since September of 1981, the Federal Reserve has guided 10-year Treasury rates from a peak of 15.84% to a low of 0.55% in July of 2020.This decline has been engineered in keeping with the Fed’s “dual mandate” to manage employment rates and inflation through rate adjustments; using rate hikes to cool economic activity, and rate reductions to energize it. With rates near zero, it’s natural to consider when they might begin to rise and what impact that shift might have on your investments. A rising interest rate environment can dramatically affect a portfolio constructed during a period of falling rates. Bond performance, stock performance, dividends – all may be negatively impacted as interest rates rise. One recent example: when the Federal Reserve increased rates in December of 2018, the Dow dropped 15% from its Q4 high while high-yield bonds also fell.2 Two of the biggest considerations for investors: 1) how to prepare your portfolio for a rising rate environment, and 2) when to enact those portfolio shifts. Investment Strategies to Consider Here are two time-tested portfolio adjustments investors have used to help counter the effects of rising rates in the past:

  • Reducing bond duration. Consider shifting from long-term to medium- and short-duration bonds or bond funds. Floating rate bonds are another option to consider.
  • Investing in stocks that pay dividends – especially growth companies with histories of steadily increasing dividends – may also help outstrip rising rates over time.
  Recent Fed Policy Developments The Fed’s dual mandate has meant that rate increases have been likely whenever inflation has crept toward their 2% inflation target. In August of 2020, at the Federal Reserve’s annual Economic Policy Symposium, the Fed described their shift to “average inflation targeting,” a move that is widely expected to extend the recent period of low interest rates.3   The Bottom Line The effect of rising U.S. interest rates will likely be felt globally, but your investment portfolio is unique to you. The timing of portfolio changes, as well as the potential benefits of the strategies described above, should all be determined in the context of your specific risk tolerance, income needs, and investment performance goals. If you would like a second opinion on your financial situation, just click here to schedule a complimentary call with us.   Important Disclosures: The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. The information provided is not intended to be a substitute for specific individualized tax planning or legal advice. We suggest that you consult with a qualified tax or legal advisor. LPL Financial Representatives offer access to Trust Services through The Private Trust Company N.A., an affiliate of LPL Financial. Sources 1   2 DJI values of 26,447 on 10/5/18 and 22,445 on 12/21/18 = a 15.1% drop.   3