When interest rates rise, the cost of borrowing goes up, which immediately impacts short-term adjustable-rate loans. It also bleeds into more stable debt products like mortgages, car loans, and business loans. These changes can have a ripple effect on the economy, including sometimes resulting in a recession.
It’s important to prepare your finances and your investment portfolio in advance of a rising interest rate environment. If you have the investment know-how and fortitude, these may even be investment opportunities for longer-term stability.
Here are several options, from specific recommendations like which stocks to focus on, to macro suggestions like how to manage your debt.
The short version
- Rising interest rates can be bad for some sectors but will have minimal impact on others. You can adjust your portfolio to take advantage.
- Consumer staples like health care, education, and hygiene products tend to remain stable in rising interest rate environments.
- You can insulate your personal finances from rising interest rates by locking in loans with fixed rates and investing in short-term bonds.
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Read MoreBest stocks for rising interest rates
Yes, rates are up, but these changes shouldn’t cause you to consider abandoning the stock market. There are plenty of companies that won’t be affected by rising rates — in fact, some will even benefit from higher interest rates.
These stocks are considered defensive stocks, which means they provide consistent returns regardless of what’s happening with the broader stock market or the economy. We’ve singled out three that we think are a good buying opportunity.
Equifax
A credit data provider and one of three major providers of modern-day credit scores, Equifax (EFX) plays an essential role in consumer lending — which is good in a rising interest rate environment. As interest rates rise and loans become more difficult to obtain, consumers are likely to start paying closer attention to their credit scores to qualify for the best rates. Equifax’s demand should remain steady moving forward or even increase.
In addition, Equifax has been on a path to expansion in recent years. The company has purchased a series of smaller organizations to expand into financial services. According to Crunchbase.com, Equifax has made 30 acquisitions, the most recent of which was LawLogix Group Inc. This multimillion-dollar company helps Americans with its Electronic I-9 Compliance, E-Verify, and Immigration Case Management software.
Extra Space Storage
As interest rates rise, consumer spending habits change. In particular, many consumers may downsize their living space or put off upsizing when needed. That’s where self-storage comes in. Extra Space Storage (EXR) is primed to take advantage of these changing habits.
With over 1,900 self-storage sites in 40 stages, Extra Space Storage is one of the largest self-storage companies in the U.S. As a real estate investment trust (REIT), it generates steady income from its properties that it's required to deliver back to its shareholders in exchange for preferential tax treatment.
Discover financial services
While some organizations buckle under the pressure of rising interest rates, others benefit from it. One example is Discover Financial Services (DFS), a company you might’ve seen in someone’s wallet.
Discover is best known for its credit cards. While they were traditionally less popular than lending giants like Visa and American Express, their portfolio has been growing steadily in recent years. Discover Financial Services also has a digital banking division that's experiencing rapid growth.
Discover Financial Services is a good choice because they're in the business of lending money to consumers and will benefit when interest rates rise by increasing the interest charges on its consumer lending products.
Read more: 5 Best Retail Stocks to Buy During This Inflationary Environment
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Skip the waitlistBest sectors for rising interest rates
While it’s tough to time the market (some even say it’s a fool’s game), several sectors have historically weathered higher interest rate environments better than others.
These sectors tend to have inelastic demand, a term that economists use to refer to a situation where demand for an item stays the same regardless of its cost or other factors change.
In this case, specific sectors will remain in demand irrespective of rising interest rates because consumers need these industries to live their lives. We’ve outlined several of these sectors below.
Consumer staples
Certain industries will perform well no matter what is happening with the economy. Consumers need these products to survive and may even stock up before or while interest rates rise. Consumer staples like essential food and beverages (think Campbell’s soup, not specialty items), household goods like toilet paper and detergent, and hygiene products will all be in demand.
Finally, while this may seem counterintuitive, alcohol and tobacco tend to have highly stable demand. Consumers are reluctant to give up on these vices during stressful times.
You have options if you’re looking to invest in consumer staple stocks. You could choose an exchange-traded fund (ETF) like Consumer Staples Select Sector SPDR ETF (XLP) or buy individual securities like Tyson Foods Inc. (TSN), which is one of the largest producers of beef, pork, and chicken in the country.
Related:Best S&P 500 ETFs for 2022
Healthcare, education and HVAC
As with the consumer staples mentioned above, there are also some service sectors that consumers will need no matter what. These sectors usually involve basic survival and don’t experience fluctuations in demand like other industries. Prime examples of stable sectors include healthcare, education, and heating and cooling.
Th healthcare industry can be particularly resilient. If you’re looking to invest in this sector, there are several ETFs to purchase, like Vanguard Health Care (VGHCX). Alternatively, you could buy healthcare stocks directly. Some good options include the Danish pharmaceutical company Novo Nordisk A/S (NVO), and Bio-Rad Laboratories, Inc. (BIO), a company that sells diagnostic equipment.
Banks and brokerages
Rising interest rates can be a good thing in the financial sector, especially for any company that makes a business out of lending. Banks should see increased revenue as they earn more money from lending to consumers.
Banks are also a good buy during inflationary periods because as costs for items like cars and homes go up, so do loan amounts and interest earned on those loans.
Brokerages are another excellent option if you’re looking to invest in the financial sector in a rising interest rate environment. Investment firms tend to perform better during uncertain economic conditions, as fund managers take advantage of larger than usual market fluctuations.
Cash-rich companies
While banks earn more money during periods of high interest rates due to lending, other companies will do well because they’re earning interest on their large cash reserves. To find a company with a large cash reserve, find organizations with a low debt-to-equity (D/E) ratio or companies with a large portion of their book value held in cash.
If you’re looking for a cash-rich company, the tech sector is an excellent place to start. Tech companies tend to hoard a lot of cash on their balance sheet, with prime examples including Apple (AAPL), Google’s parent company Alphabet (GOOGL) and Microsoft (MSFT). These three tech companies are collectively sitting on more than $1 trillion in cash.
Learn more :Â What Are FAANG Stocks?
Other investments to consider when interest rates rise
Investing isn't just about picking the right stocks or sectors. Here are some additional steps a prudent investor can take when interest rates are rising.
Invest in short-term bonds
Bonds are essential to any well-balanced portfolio and can provide a good source of income when interest rates rise. To protect yourself against rising interest rates, stick with short-term bonds, as the price of long-term bonds will decrease when interest rates rise.
Short-term bonds are more resilient and less affected by fast-rising interest rates. And once a short-term bond matures, you can reinvest the money in a new short-term bond at higher interest rates.
Buy or invest in real estate
Finally, investing in real estate, either by purchasing REITs or buying real property, can be an excellent way to prepare your investments for rising interest rates.
If you’re purchasing physical property, you may be able to generate cash flow right away. That said, run the numbers carefully, especially if you have to borrow to purchase.
As we mentioned above, REITs are required to return almost 100% of their profits to their shareholders to enjoy their tax-advantaged status. So any REIT you purchase should continue to offer steady distributions, even when interest rates are rising.
Feeling bold?:3 Benefits of Buying a Home When Interest Rates Are High
How to protect your personal finances when interest rates are rising
Preparing for rising interest rates is about more than just investing. It’s also about managing your finances and using debt wisely.
If you have any variable rate debt, like student loans, a mortgage, or a personal line of credit, it would be wise to explore your options to lock into a fixed interest rate — even if the rate is higher.
The Federal Reserve has signaled that they think interest rates will continue to rise into 2023, so locking into a fixed rate now will give you stability and potentially insulate you against higher rates in the future.
If you speak to your lender and ask about locking into a fixed rate, don’t be surprised if the rate they provide is more than the variable rate you are paying now. You’ll need to weigh the cons of paying a higher rate versus the possibility of your variable rate exceeding the offered fixed rate in the future.
If you think rates will continue increasing, the fixed rate could make more sense in the long run.
Bottom line
A rising interest rate environment can significantly impact your portfolio, but it doesn't have to spell calamity. And it doesn’t mean you should hide your money under a mattress.
If you follow the steps above, you can prepare your finances and investment portfolio for rising interest rates. And you may even position yourself to take advantage of these changing market conditions.
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