How Are You Prepping Your Investments for Rising Interest Rates?

Daniel Penzing
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Invest in Companies More Resistant to Rising Interest Rates

Since interest rates will go up, many companies will see their interest expenses increasing, which will affect their earnings. Although interest rates will probably not be going up significantly in the short term, it will be a factor in the future. When interest rates do increase again, investors will become much less accommodating of companies with high interest expenses. This is why investors are often looking for companies that are more likely to be more resistant or can absorb rising interest rates much more easily. Here are some ways to help you follow this approach when you make your investment decisions.

Invest in companies that don’t have operating leverage; these are companies that must spend a significant part of their profits to support their fixed operating costs. In other words, companies with no operating leverage have generally higher margins and maintain them fairly stable over time. Examples of these companies are Coca-Cola, Pfizer, Walmart and Berkshire Hathaway.

Invest in companies that are more focused in their businesses; companies that come up with one good product and keep improving it with technologies and features over the years tend to have some level of operating leverage because they have limited other expenses to support. Examples of these types of companies are Microsoft, Google and Facebook. Amazon controls their major cost of business, which is how they maintain their margins, and you can expect them to become more profitable as they sell more goods.

Invest in Companies with a History of Increasing Their Dividends

When interest rates are rising, you will want to have yields on your investments that will keep pace with the rising rates. The best way to do this is to find companies that have consistently increased their dividends over the last several years.

Thus, you should screen for companies that have raised their dividends publicly for at least four consecutive years.

Make Sure the Dividends Are Safe

The financial crisis of 2008 changed the investment world in many ways. One of the changes that it brought is the amount of attention that investors pay to a company’s dividend safety.

In the past, many investors viewed a high yield as an essential requirement for safe and stable investments. As the financial crisis grew, it became very clear that even high-yield, high-risk investments can carry risks that are too high for some investors. These days, a company’s dividend safety is seen as an essential property of its investments.

As such, you will want to consider the safety of the companies that you have in your portfolio. That’s why you should screen for companies that have at least one year of dividend safety above 80%.

When you combine safe dividends with steadily increasing yields over several years, you will have a very strong safety net as interest rates continue to rise.

Invest in Stocks of Companies with Low Debt Levels

When it comes to investment safety, a significant factor to consider is a company’s debt level. As the Federal Reserve begins raising interest rates, many investors worry about their bond holdings (which will likely fall in value as interest rates go up).

However, as you target a higher interest rate environment, be aware that there are a number of factors involved with higher interest rates. Companies with low debt levels result in a lower risk of defaulting on their loans. Keep in mind that companies can lower the value of their debt through debt-equity conversions, mergers or buyouts, which ultimately lead to a reduction of the company’s total debt.

Investment opportunities exist for corporations that operate with a low debt level. Typically, such companies are established leaders in their industries … with credit ratings that reflect their stability. Such is the case with Microsoft, which carries a 0% debt level.

As another example, General Motors® (GM) is a well-established company that is focused on strengthening its position in the automotive industry.

With its debt-to-equity ratio of 0.16, GM is well positioned to take advantage of rising interest rates. Even though its debt levels are low, its interest coverage ratio is more than 3 and compares favorably to most industries.

Reduce Exposure to Long-Term Debt Securities

The first step is to reduce your exposure to debt securities such as bonds, as higher inflation tends to make the prices of these securities decline. While on the surface this would seem to be a bad thing, it’s actually not. Why? Well, with the government insuring the repayment of these securities, the price is only an estimate about the expected future of the economy, the company issuing the bond, and government decisions.

Next, when deflation hits, the price of these securities tends to fall as their value relative to the general economy decreases. The sudden change in price in these long-term securities can make you lose more or even all of your investment. Therefore the best way to avoid this is to avoid them entirely.

Invest in Stocks

This may seem a little odd because we are normally told that stocks are risky. But in this case, the reverse is actually true. With the stock market having a higher inflation rate, they actually increase in value with inflation. And as the economy recovers and prevents deflation from taking hold, when interest rates rise, the stock prices will generally rise as well.

Park Extra Cash in Money Market Funds

The coming rise in interest rates is one of the biggest investment stories of 2017.

After nearly a decade during which rates were historically low, the Federal Reserve is finally ready to move. And they may go faster than the market expects. You see, the Fed is under more pressure than they can handle – which is why they issued a surprise, December interest rate hike. It’s also why they’ve stated their intention to raise rates several more times in 2017.

So what does that mean for savers? Well, the Fed’s plan to raise interest rates will quickly change the yield curve. This means that its short-term standard bank rates will climb higher than its longer term rates.

Here’s the important part – This will cause the popular 5-year CDs to become the best yield available from banks. The problem is that banks won’t stop at 5-year CDs. As they start to see competition from other banks, they’ll quickly move to 6-year CDs or even 7-year CDs.

But here’s why that’s important.