Consider the risks, and plan accordingly.
After recent years at historic lows, interest rates are now reversing course as the U.S. economy continues to improve. The Federal Reserve has increased rates several times over the past 24 months and experts forecast another hike in June. While rates will remain relatively low in the foreseeable future, gradual increases are expected to continue, which can be a risk for bondholders. Rising rates may also increase risks for stock investors, as research has shown that rising rates may drive stock prices down or lead to greater volatility.
In our 2018 Advisor Authority survey of more than 1,700 financial advisors and investors, RIAs and fee-based advisors cited rising interest rates as the number one factor impacting their clients' portfolios over the next 12 months-and one of their clients' top five financial concerns. Yet, clients may be relatively unaware of the threat, as only 8% of investors cited rising rates as a concern.
Advisors continue to assess how rising rates may impact their clients and are taking appropriate action-while maintaining a focus on clients' long term goals. Some of these solutions are intended to reduce or effectively eliminate the impact of rising rates, while other strategies may be designed to potentially benefit from a rise in rates. Options include:
Lock in Low Rates
Lock in mortgages at current low rates before they rise. If eligible to refinance, this may be a good opportunity to do so.
Trim Bond Duration
Move to short-term bonds, which are less sensitive to rate increases than longer-maturity bonds, and will provide the opportunity to reinvest over the short term.
Pair Short-Term Bonds With Less Rate-Sensitive Bonds
TIPS are adjusted in line with the CPI, so as price levels rise, the coupon payments move similarly. Floating rate bonds, tied to a benchmark such as Libor, will go up if the benchmark rises.
As each bond matures, rising rates allow clients to reinvest into new bonds at higher rates.
Rebalance/Reposition Stock Holdings
Certain industries and sectors are likely to benefit from a rate hike, such as Financial Stocks. Dividend-paying stocks, real estate-related investments, and commodities also have performed well when rates rise. Of course, it is important to remain diversified.
Interest Rate Hedged Funds and ETFs
These can allow an investor to continue to earn higher yields while potentially offsetting some or all risk associated with higher interest rates. However, many of these are relatively new, with a limited track record, so due diligence is important.
Inverse ETF or Funds
Specifically designed to increase in value as interest rates rise and bond prices decline. While potentially effective for hedging risk due to rising rates, this category tends to be volatile, so a poorly timed entry can hurt overall portfolio returns. It is important to understand the risks.
Our latest research shows that RIAs and fee-based advisors remain focused on the long-term-while taking action to protect their clients' portfolios and preparing for opportunities to create more value. Times like these prove the importance of holistic advice from unbiased advisors, who can protect clients from the risks they may not see-or may not fully understand-so they can stay the course, build more wealth and ultimately achieve their financial goals.
By: Craig Hawley, Head of Nationwide Advisory Solutions
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