Interest rates are going up, which can present a problem for anyone with a mortgage or other fixed-rate loan. Unfortunately, this isn’t the first time rising interest rates have presented challenges to investors. It happened in the early 1980s as well as the late 1990s and early 2000s. In fact, historically speaking, it tends to happen at regular intervals of about every 20 years. Not all markets respond the same way to rising interest rates. Some housing markets see volume decline as buyers are unable to qualify for mortgages due to higher interest rates. Other markets see prices decline as demand falls and properties become unaffordable for many potential buyers—especially first-time homebuyers who tend to be sensitive to changes in interest rates. To mitigate these risks and increase your chances of meeting your financial goals, you should know what will happen when interest rates rise and what actions you can take now that they have begun doing so.
When interest rates rise, it can be scary for investors. But those who understand the risks and opportunities can benefit from rising interest rates. It’s important to have a well-balanced portfolio that is diversified across different investments and asset classes. Keeping your investment strategy diversified will help you manage the risks associated with rising interest rates and any resulting market corrections. Here are some strategies to invest in this volatile market environment.
Increased interest rates can impact your ability to refinance and qualify for new mortgages. A rise in interest rates can reduce the number of people who refinance their mortgages, putting downward pressure on demand for mortgage refinancing. This can lead to a decrease in the price of mortgage-backed securities (MBS), which are used to fund about half of all mortgages in the country. Rising interest rates also make it more difficult to qualify for a new mortgage, which can put downward pressure on demand for new mortgages and decrease the average rate on new mortgages. For example, suppose you currently have a 5/1 adjustable-rate mortgage with a 4.5% interest rate and want to refinance to a 30-year fixed-rate mortgage. In that case, you will pay about $7,500 less per year in interest when rates are 4% instead of 4.5%. But if rates go to 5%, you will pay about $7,500 more per year in interest. That’s a $14,000 difference every year.
You may have heard that you can get a lower interest rate by paying a higher upfront mortgage origination fee. When interest rates are rising, this is almost always a bad deal because the higher interest rates will make the mortgage cost more overall. However, some lenders offer adjustable-rate mortgages (ARMs) with a lower interest rate upfront. If you are considering placing a bet on falling interest rates, you need to factor in that it takes time for interest rates to change. Current estimates suggest that rates will take at least six months to rise from their current level of about 4.5% to 5.5%. And it will likely take much longer than that to reach their full potential.
If you are short on time, the best way to deal with rising interest rates is to lock in your rate now. Short-term investments are riskier than long-term investments, but locking in your rate can protect your long-term investments from rising rates. Remember that you will pay a small fee to do this, known as a premium. There are also a few strategies that can help you manage the impact of rising rates on your overall portfolio. If you have a long-time horizon, you can consider shifting some of your investments from stocks to bonds or cash. This can help offset the impact of rising rates on stocks and is especially helpful for younger investors who may have a long-time horizon for saving for retirement. You can also look for more defensive stocks that perform better in rising-rate environments.
Many experts believe that this rising-rate cycle will be different than past cycles. But it’s impossible to know exactly how it will play out. That’s why it’s important to take a longer-term approach to investing. Investing to meet your long-term goals over the short term is the best way to deal with uncertainty. Investing in a wide range of assets, including stocks, bonds, and cash, helps you increase the chance of meeting your financial goals. It also allows you to diversify the impact of any given investment. For example, if you have a lot of your money invested in stocks, and stocks drop, you may be worried about how you will meet your financial goals. But if you have a wide range of investments and stocks drop, you may only need to sell off a small number of your stock investments to meet your goals.
Interest rates are rising, but that doesn’t mean that every type of investment will benefit. When interest rates rise, the value of fixed-income investments (bonds, CDs, money market accounts) typically falls. Meanwhile, equity investments (stocks) usually rise in value, but not always. This means your portfolio will benefit from diversification. By diversifying your portfolio across different investments and asset classes, you can reduce the risks associated with interest rates and market corrections.
The best way to deal with market corrections is to be prepared for them. Market corrections happen periodically, and they can cause significant drops in stock and bond markets. You can protect yourself from market corrections by investing a portion of your portfolio in cash, credit, and short-term bonds. You can quickly sell these investments if you need cash, like if you lose your job and need to pay off your credit card debt. Then, when the market recovers, you can reinvest in the stocks and bonds you originally chose to sell.
While interest rates and the stock market are increasing, inflation is also on the rise. This means that now is a great time to include inflation-adjusted investments in your portfolio, such as real estate, commodities, and gold. Real estate, commodities, and gold all have the potential to increase in value when there is high inflation. At the same time, they are uncorrelated to the stock market. In other words, they don’t rise and fall with the stock market. You can invest in real estate through real estate investment trusts (REITs). You can invest in commodities through exchange-traded funds (ETFs) that track the commodities market. And you can invest in gold and other precious metals through gold bullion coins or exchange-traded funds that track the gold market.
Once interest rates are back to normal, you’ll want to evaluate your portfolio’s performance. You can do this by calculating your portfolio’s net-worth value over time. This will help you determine whether your investment strategy has been effective. That way, you can course-correct if necessary. For example, suppose you notice that your portfolio is too heavily weighted in stocks. In that case, you can rebalance your portfolio to reduce your risk. You can sell some of your stocks and invest the proceeds in fixed-income investments, like bonds and CDs. This will help balance out your portfolio and reduce your risk.
Rising interest rates can be challenging for many investors but can also provide opportunities for others. If you have time, you can wait for rates to rise further before locking in your rate on a new mortgage or refinancing an existing loan. If you don’t have time, you can wait for rates to rise and lock in your rate now, or you can shift some of your assets to bonds or cash to help insulate your portfolio against rising rates.