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How To Invest As Interest Rates Rise

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Learn How To Invest As Interest Rates Rise

Interest Rates RiseWith the unemployment rate falling into the 5 percent range and jobs being created in the United states at a rate of over 200,000 per month, it is a good time to take a look at how to invest as interest rates rise. The United States Federal Reserve is expected to completely end the Quantitative Easing (QE) program in October 2014. After the end of Quantitative Easing, the next market moving Federal Reserve event is the eventuality that they will start raising short-term interest rates gradually to dampen inflation pressures and return short-term interest rates to levels that are consistent with a growing United States economy. How quickly the Federal Reserve starts to raise interest rates is a matter of debate; however, now is the time to figure out which investments make sense as interest rates rise, and which ones should be avoided.

Ways To Invest As Interest Rates Rise

There are many ways to invest as interest rates rise.   The key to investing wisely as interest rates rise is to understand how far into the interest rate raising cycle the Federal Reserve is and the general state of the economy. This is because you want to employ specific investment strategies as interest rates begin to rise, then modify or change your investment strategies as the Federal Reserve continues to raise interest rates and a recession looms in the not too distant future.

The following are some sensible ways to invest as interest rates rise:

Use CD Laddering To Earn The Most From CDs As Interest Rates Rise

CD laddering is an investment strategy that makes a lot of sense to undertake as interest rates rise. If you have a specific amount of money that you would like to invest in a safe Federal Deposit Insurance Corporation (FDIC) insured Certificate of Deposit (CD), use a CD ladder investment strategy to average into several Certificate of Deposits over a period of months or years at increasingly higher yields, rather than making one large investment in a Certificate of Deposit as interest rates begin to rise. Averaging into Certificate of Deposits as interest rates rise provides two advantages. First, the average yield you earn will be higher than if you purchase one large Certificate of Deposit initially, because you will be buying higher yielding Certificate of Deposits as interest rates rise. Second, if interest rates rise for a sustained period of time, you can reinvest some of the early Certificate of Deposit investments at even higher interest rates, as they mature and become available for reinvestment.

Buy Financial Instruments That Rise As Interest Rates Rise

One of the advantages of investing today versus decades past is that numerous creative financial instruments are now available that can be used to make money during just about any financial scenario.   Investors can purchase Exchange Traded Funds (ETFs) that rise in price as United States Treasury Bonds interest rates increase and the price of treasuries go down. This is a more speculative investment strategy than CD laddering, since it relies upon interest rates to rise to make money; however, it can be highly profitable during a period of sustained increases in interest rates, since the Exchange Traded Funds will increase in value in response to higher interest rates paid for United States Treasury Bonds.

  • ProShares UltraShort 20+ Year Treasury (NYSE: TBT) is an ETF that is designed to increase by two times the inverse of the daily investment results of the Barclays U.S. 20+ Year Treasury Bond Index.
  • ProShares UltraShort 7-10 Year Treasury (NYSE: PST) is an ETF that is designed to increase by two times the inverse of the daily investment results of the Barclays U.S. 7-10 Year Treasury Bond Index.

Get Long The United States Dollar As Interest Rates Rise

Invest In US Dollar
As the Federal Reserve increases interest rates in the United States, foreign investors pour money into the country and increase the value of the United States Dollar. You can play this increase in the United States Dollar by purchasing PowerShares DB US Dollar Bullish ETF (NYSE: UUP), which is an Exchange Traded Fund that is designed track the performance of the Deutsche Bank Long US Dollar Futures index. UUP invests in long futures contracts that increase in value as the United States Dollar increases in value against a number of major world currencies.

Investments To Avoid As Interest Rates Rise

Rising Interest Rates Falling Bonds
Bonds tend to perform poorly as interest rates rise, because bonds lose principal value as the interest they pay increases. If the Federal Reserve raises interest rates, interest paid by a wide variety of bonds will rise in lock-step with the Federal Reserve’s increases in interest rates. Coming off an extremely low rate environment, many bonds are inflated in price and will lose a significant amount of their principal value as interest rates rise to levels that are considered normal during economic expansions.   Money invested in bonds may perform well if the bonds are held to maturity, but for investors that need the money before the bonds mature, they are likely to be losing investments in the near and mid-term, and should be avoided as interest rates rise.

While the stock market will likely increase for at least a year or two as interest rates rise, it is important to start getting ready for the next recession and bear stock market sell-off. The first half of the period in which the Federal Reserve raises interest rates is usually a time when the stock market increases in value, since the Federal Reserve raises interest rates in response to a strong economy and inflation pressures, both of which fuel corporate earnings. However, eventually, the Federal Reserve raises interest rates too far and causes a recession. So, be prepared to act and get out of any stock position you do not want to hold through a recession.

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