In the first part of this two-part series we looked at the general macroeconomic environment for stocks and bonds in our current rising interest rate economy. Seeing that stocks, bonds and cash comprise the majority of one’s portfolio, it was here that we looked first. Even if you have an investment horizon of eternity like Cathie Wood of Arkk, you still have to keep your head in the game and pay attention to what’s going on in the markets. Rebalancing is a term often thrown around by investment advisors, perhaps in your best interest, or perhaps just churning fees, which allows you to re-allocate your investments to better suited assets in the rising rate environment.
Before we look at alternative asset classes, there are certain steps you can take to diversify your portfolio that can help you meet your longer term objectives.
Revisit Investment Goals
As mentioned, if it’s been a while since you have reviewed your portfolio, begin to think if your personal goals have changed in order to structure your investments most wisely to meet them. According to Joseph Curtin, head of CIO Portfolio Management for Bank of America Private Bank, “Given the background of inflation, slower growth, shifting monetary policy and rising interest rates, we think investors should look at ways to reposition their portfolios for 2023 and beyond.”
Avoid Concentrated Positions
Diversification by nature says not to overload yourself in a particular asset or asset class. Those risks may be less pronounced when assets are performing well, but in volatile markets like the present moves may be pronounced and have a drastic effect on your wealth. Unless they offer clear benefits, reducing concentrated holdings could give you greater diversification to withstand unpredictable markets.
Take an Active Approach
Warren Buffet would tell you to buy an S&P 500 index fund and forget about it. That’s passive investing. Again, whether it is actually of benefit to you, or are advisors just churning fees, is the notion of active investing. At a time of slower growth and greater volatility, however, passive investing may become less effective. While there are no guarantees that active investing will generate specific returns or outperform passive investing, these skills come to the fore when markets overall are growing more slowly.
Examine Bond Holdings
It was brought to my attention today that municipal bonds on the long end of the yield curve are now viable tax-free options to add to your portfolio. With that said, all bonds are not created equal and more advisors than not are recommending other avenues, because rising rates will generally lower the value of bonds that might currently be in your portfolio. Most analysts will then suggest buying bonds with a shorter duration, because they are not as sensitive to rate changes. If you have a laddered bond portfolio and are holding to maturity then you won’t be affected by changing rates.
So just what are these other asset classes that can be utilized now? Let’s take a look.
Real Estate
You might be thinking that all I’ve read lately says mortgage rates are at highs of decades past and prices are through the roof keeping buyers out of the market. Well, that would be correct. When interest rates rise, mortgage rates rise as well, putting a damper on the real estate market. In fact, since the beginning of 2022, the Real Estate Select Sector SPDR Fund is one of the worst-performing sector ETFs in the stock market. But real estate market weakness can be an excellent buying opportunity. In addition, rental demand may increase as fewer people can afford to buy homes. Therefore, investing in rental properties during rising interest rates can be profitable.
Investing in Real Estate Investment Trusts (REITs) can be a smart strategy for profiting from rising interest rates. One advantage of investing in REITs during periods of rising interest rates is that they tend to be less sensitive to interest rate fluctuations than other types of bonds and stocks. Additionally, REITs are required by law to pay out at least 90% of their taxable income to shareholders in the form of dividends, which can provide a steady income stream for investors.
Equity Sector Rotation
Investing in sectors that tend to perform well in a rising interest rate environment can be a smart strategy for maximizing returns during periods of increasing rates. Certain sectors, such as financials, real estate, and consumer staples, have historically performed well in a rising interest rate environment. Financials, for example, can benefit from higher interest rates because it increases their net interest margins, which is the difference between the interest income earned on loans and the interest expense paid on deposits. Consumer staples, on the other hand, tend to perform well in a rising interest rate environment because they provide essential goods and services that people need regardless of the economic climate.
Commodities or Natural Resources
While not in the wheelhouse of the average investor, investing in commodities or natural resources can be a smart strategy for profiting from rising interest rates. Investing in commodities or natural resources can provide diversification to a portfolio and potentially protect against inflation, as prices for these goods tend to increase during periods of inflation. In addition, the correlation of commodities with equities is low or actually negative, thus providing a more balanced, efficient portfolio if a certain portion is allocated to commodities.
Rising interest rates can create both challenges and opportunities for investors. While they can lead to higher borrowing costs and slower economic growth, they can also provide the chance to earn higher returns on investments and protect against inflation. Good luck out there!
