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How to Invest for Rising Interest Rates
Although many investors and analysts focus on interest rates being low, rising interest rates change the landscape of the marketplace for businesses and individual investors. Here’s how investors can profit from rising interest rates.
Key Takeaways
- Investing in rising interest rates can be successfully done by investing in companies that will do well with higher rates—such as brokers, tech and healthcare stocks, and companies that have a large cash balance.
- Investors can also capitalize on the prospect of higher rates by buying real estate and selling off unneeded assets.
- Short-term and floating rate bonds are also good investments during rising rates as they reduce portfolio volatility.
1. Invest in Brokerage Firms
Brokerage firms earn money from the interest earned on cash balances held in client accounts. Naturally, they earn more interest when rates are higher. A review of the 2003-2004 period, when the federal funds rate rose from 1.25% to 2.25%, shows major online brokers such as E*Trade and Charles Schwab enjoyed a 38% increase in interest income and a resulting 10% improvement in operating profit margins.
2. Invest in Cash-Rich Companies
Cash-rich companies will also benefit from rising rates, earning more on their cash reserves. Investors can look for companies with low debt-to-equity (D/E) ratios or companies with large percentages of book value in the form of cash.
3. Lock in Low Rates
Individuals with adjustable-rate mortgages (ARMs), or companies with adjustable-rate financing of any kind, would be well-advised to refinance with fixed-rate financing, locking in the lowest possible interest rates for the long term.
4. Buy With Financing
Individuals or businesses planning major purchases or capital expenditures should consider buying now while they still have the ability to lock in low long-term rates. Purchases made before interest rates begin to significantly rise can result in substantial savings in financing charges and overall long-term costs.
5. Invest in Tech, Healthcare
Most companies in the technology and healthcare sectors hold on to greater amounts of profits as retained earnings to reinvest in growth, rather than paying them out in the form of dividends. Past history shows that such a stance usually leads to increased revenues in a rising rate environment. In the past 13 periods of rising interest rates—over the past half-century—the healthcare and technology sectors experienced average gains of 13% to 20% during the first year following an interest rate increase. In comparison, the overall average gains for the S&P 500 Index were only between 6% and 7%.
6. Embrace Short-Term or Floating Rate Bonds
Bond investors can decrease portfolio volatility during rising-rate environments by moving to bonds with shorter terms to maturity or by purchasing bonds with coupon rates that float in concert with the market rate.
7. Invest in Payroll Processing Companies
Payroll processors, such as Paychex and Automatic Data Processing, customarily maintain large cash balances for customers in the periods between paychecks, when the money is distributed as payroll. These firms should see improved interest revenues when interest rates rise.
8. Sell Assets
Individuals or businesses with unneeded property or other assets may be able to profit from selling such assets before rates begin to rise. Buyers are likely looking to buy now when they can still lock in low, long-term rates, so they may be willing to pay premiums to acquire needed assets before rates begin going up.
9. Lock in Long-Term Supply Contracts
Rising rates generally mean rising prices as well. Businesses that can lock in long-term contracts with suppliers may be able to enjoy better margins by avoiding increased prices for as long as possible.
10. Buy or Invest in Real Estate
Real estate prices tend to rise with, and often even outpace, interest rates. Buying real estate or investing in real estate investment trusts (REITs) is another way to realize profits from a rising rate environment.
Rising interest rates may sound like a bad thing for those who need to take out a loan or buy something on credit, but investors can profit by planning ahead and purchasing the right types of investments.
A Guide to Understanding Opportunities and Risks in Futures Trading
Basic Trading Strategies
Dozens of different strategies and variations of strategies are employed by futures traders in pursuit of speculative profits. Here are brief descriptions and illustrations of the most basic strategies.
Buying (Going Long) to Profit from an Expected Price Increase
Someone expecting the price of a particular commodity to increase over a given period of time can seek to profit by buying futures contracts. If correct in forecasting the direction and timing of the price change, the futures contract can be sold later for the higher price, thereby yielding a profit. If the price declines rather than increases, the trade will result in a loss. Because of leverage, losses as well as gains may be larger than the initial margin deposit.
For example, assume it’s now January. The July crude oil futures price is presently quoted at $15 a barrel and over the coming month you expect the price to increase. You decide to deposit the required initial margin of $2,000 and buy one July crude oil futures contract. Further assume that by April the July crude oil futures price has risen to $16 a barrel and you decide to take your profit by selling. Since each contract is for 1,000 barrels, your $1 a barrel profit would be $1,000 less transaction costs.
| Price per barrel | Value of 1,000 barrel contract | ||||||||||||||||||||||||||||||||||||||||||||||||
| January | $15.00 | $15,000 | |||||||||||||||||||||||||||||||||||||||||||||||
| April | $16.00 | $16,000 | |||||||||||||||||||||||||||||||||||||||||||||||
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* For simplicity, examples do not take into account commissions and other transaction costs. These costs are important. You should be sure you understand them. Suppose, instead, that rather than rising to $16 a barrel, the July crude oil price by April has declined to $14 and that, to avoid the possibility of further loss, you elect to sell the contract at that price. On the 1,000 barrel contract your loss would come to $1,000 plus transaction costs.
Note that if at any time the loss on the open position had reduced funds in your margin account to below the maintenance margin level, you would have received a margin call for whatever sum was needed to restore your account to the amount of the initial margin requirement. Selling (Going Short) to Profit from an Expected Price Decrease The only way going short to profit from an expected price decrease differs from going long to profit from an expected price increase is the sequence of the trades. Instead of first buying a futures contract, you first sell a futures contract. If, as you expect, the price does decline, a profit can be realized by later purchasing an offsetting futures contract at the lower price. The gain per unit will be the amount by which the purchase price is below the earlier selling price. Margin requirements for selling a futures contract are the same as for buying a futures contract, and daily profits or losses are credited or debited to the account in the same way. For example, suppose it’s August and between now and year end you expect the overall level of stock prices to decline. The S&P 500 Stock Index is currently at 1200. You deposit an initial margin of $15,000 and sell one December S&P 500 futures contract at 1200. Each one point change in the index results in a $250 per contract profit or loss. A decline of 100 points by November would thus yield a profit, before transaction costs, of $25,000 in roughly three months time. A gain of this magnitude on less than a 10 percent change in the index level is an illustration of leverage working to your advantage.
Assume stock prices, as measured by the S&P 500, increase rather than decrease and by the time you decide to liquidate the position in November (by making an offsetting purchase), the index has risen to 1300, the outcome would be as follows:
A loss of this magnitude ($25,000, which is far in excess of your $15,000 initial margin deposit) on less than a 10 percent change in the index level is an illustration of leverage working to your disadvantage. It’s the other edge of the sword. While most speculative futures transactions involve a simple purchase of futures contracts to profit from an expected price increase — or an equally simple sale to profit from an expected price decrease — numerous other possible strategies exist. Spreads are one example. A spread involves buying one futures contract in one month and selling another futures contract in a different month. The purpose is to profit from an expected change in the relationship between the purchase price of one and the selling price of the other. As an illustration, assume it’s now November, that the March wheat futures price is presently $3.50 a bushel and the May wheat futures price is presently $3.55 a bushel, a difference of 5¢. Your analysis of market conditions indicates that, over the next few months, the price difference between the two contracts should widen to become greater than 5¢. To profit if you are right, you could sell the March futures contract (the lower priced contract) and buy the May futures contract (the higher priced contract). Assume time and events prove you right and that, by February, the March futures price has risen to $3.60 and the May futures price is $3.75, a difference of 15¢. By liquidating both contracts at this time, you can realize a net gain of 10¢ a bushel. Since each contract is 5,000 bushels, the net gain is $500.
Net gain 10¢ bushel Buying (Going Long) Rice Futures to Profit from a Rise in Rice PricesThe price of Rough Rice Futures is 14.340 USD (per hundredweight) today. Will Rough Rice Futures price grow / rise / go up?Yes. The RR price can go up from 14.340 USD to 15.181 USD in one year. Is it profitable to invest in Rough Rice Futures commodity?Yes. The long-term earning potential is +5.87% in one year. Will RR price fall / drop?What will Rough Rice Futures price be worth in five years (2025)?The Rough Rice Futures (“RR” ) future price will be 16.371 USD. Will RR price crash?According to our analysis, this will not happen. Finance English practice: Unit 34 — Futures
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