How to invest when interest rates are rising | personal financing

(Chuck Salita)

The Fed is finally realizing how entrenched inflation is and it looks like it might already be taking some serious steps to at least start addressing it. Key among those steps is to raise interest rates.

Interest rates have been on a downward trend for nearly 40 years – since the last time inflation hit this high – making the high interest rate environment something many investors have not experienced. Your investment roadmap is slightly different when interest rates are rising, so knowing how to invest when interest rates are rising is a skill that makes sense to learn. These five strategies can help you navigate what could otherwise be a tough spot in the market.

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#1: Get your balance sheet under control

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Higher interest rates mean that the cost of debt will increase. If you have debt or variable rate debt that you will need to borrow more to pay it off when it comes due, now is the time to figure out how to pay it off or secure fixed rates for it. The higher the interest rates, the more expensive the floating rate debt will become and the more expensive it will be to get new fixed rate loans.

By paying off or refinancing your debt while rates are still fairly low, you can control more of your income and cash flow. This is an important part of being able to make sure you have the funds available to invest in the first place.

#2: Keep the term of your bond fairly short

If your financial allocation plan requires you to own bonds, then in a rising price environment, you’ll want to make sure the bonds you own are fairly short-lived. This is because the longer a bond is, the more it will fall when interest rates rise.

If you intend to hold your bonds until they mature, your bond cash flows will not change just because interest rates rise. If you use your bonds as a portfolio weight or plan to sell them before maturity, however, be aware that bonds with low coupons and long times to maturity can drop considerably as prices rise. These are the types of bonds that usually have longer durations and are therefore more sensitive to higher interest rates.

No. 3: Find Your Stock Balances

The same risks that affect your ability to repay your debt when interest increases also affect the companies you invest in. As prices rise, the cost of their variable rate debt increases instantly and the cost of their fixed rate debt increases if they need to be refinanced as they mature.

This is important to realize, since a lot of corporate debt is structured as bonds where the company only pays interest until they are required to pay the entire principal when the debt comes due. As a result, you’ll want to pay attention to both its debt levels and its debt maturity schedules—both of which are often noted in a company’s annual reports.

You’ll want to make sure that the company still appears to be able to service its debt from its cash flow even as that debt goes through higher rates, requiring larger interest payments. If the debt market worries that company I can not Making these higher payments, can force the company into bankruptcy by making it impossible for it to borrow new money. This kind of action could cause her entire stock to drop to $0.

#4: Find companies with pricing power

As prices rise, companies with debt will generally see their margins shrink due to higher debt servicing costs. Those who have the ability to pass on those higher costs to their clients through higher prices are more likely to succeed than those who don’t.

Given the recent inflation, you might be able to get perspective on how aggressively a company’s pricing is by listening to conference calls about its earnings. If you hear comments like “Volumes have remained strong even as our pricing recovers commodity pressure,” that’s a very good sign that the company has at least some degree of pricing power.

Number 5: Focus on the value of the companies you own

Investors generally want the best risk-adjusted returns that they can get for the money they are putting at risk in the market. As interest rates rise, the potential future returns they can get on lower-risk investments like bonds improve, making higher-risk investments like stocks less attractive. This is the main reason why the market has fallen lately as the Federal Reserve talks about the possibility of a more aggressive rate hike.

Within this framework, companies that already appear to be of reasonable value are quite cheap compared to their legitimate cash-generating capabilities, may have much less distance to fall as interest rates rise. After all, the cheaper a company is valued, the higher the market price for it Results already installed Instead of that Rapid growth potential in the future. This makes it easier for investors to see a fast track of operating-driven returns, which can help support those companies’ share prices.

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With the Federal Reserve expected to raise interest rates by 50 basis points later this month to help combat inflation, it is very likely that we will begin an era of higher interest rates. This may make now your last and best chance to get a personal financial and investment plan to handle a higher rate environment. So get started now, and give yourself a good chance to successfully pass these high rates.

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Chuck Saletta does not have a position in any of the stocks mentioned. The Motley Fool does not have a position in any of the stocks mentioned. Motley Fool has a disclosure policy.

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