Best Interest Rate ETFs to Buy
When investors are looking for interest rate ETFs, it means they are trying to find exchange-traded funds that tend to perform better than others when interest rates are rising. Higher rates can erode at corporate earnings and cause falling prices for bonds. Therefore, identifying interest rate ETFs can be a challenge.
How to Find the Best Interest Rate ETFs
There is no dedicated category of funds that profit from rising interest rates, but there are certain types of ETFs that can perform better than others in a rising interest rate environment. Once you identify the types of funds to buy, you can narrow down to the best ETFs among those types. As with other types of ETFs, it's wise to look for low expenses and high assets.
Here are the types of funds that are generally smart holdings when interest rates are rising:
- Short-Term Bond ETFs: When interest rates are rising, bond prices are generally falling. However, some bonds are more sensitive to interest rates than others. Generally, the longer the duration on the bond, the more prices can fall when rates are rising. Therefore, short- and ultra-short-term bond ETFs are expected to perform better than intermediate––and long-term bond funds in a rising rate environment.
- TIPS ETFs: Rising rates often coincide with rising inflation because the Federal Reserve raises its Fed Funds Rate to prevent inflation from getting too hot.
- Floating Rate ETFs: These funds invest in floating rate notes, which pay a variable interest rate, as opposed to a fixed rate like conventional bonds. This means that floating rate ETFs can hold their value in a rising interest rate environment.
- Growth Stock ETFs: When interest rates are rising, the economy is generally in the mature stage of the business cycle, which tends to favor growth stocks. However, investors should use caution when buying growth stock ETFs in this phase because the next phase to follow is the recession, where growth stocks can see rapid declines.
- Financial Sector ETFs: Banks that loan money to consumers can do well in rising rate environments because the spread between what they pay savers for savings accounts and what they can earn from high-quality debt, such as U.S. Treasuries widens. Like growth stocks, financial stocks can see big declines once signs of recession appear.
Best Interest Rate ETFs
Based upon the best types of ETFs for rising interest rates, we did the homework for you and researched dozens of funds to highlight five interest rate ETFs in five different categories to consider for your portfolio.
- iShares Short Treasury Bond ETF (SHV): This short-term bond ETF invests in U.S. Treasury bonds with maturities less than one year. The short duration reduces interest rate risk compared to longer durations and can even produce positive returns in a rising interest rate environment. Assets are over $15 billion and expenses are just 0.15% or $15 for every $10,000 invested.
- iShares TIPS Bond ETF (TIP): By far the largest ETF that invests in Treasury Inflation-Protected Securities, aka TIPS, the TIP ETF has over $22 billion in assets and has a low expense ratio of 0.20%.
- iShares Floating Rate Bond (FLOT): This floating rate bond ETF offers exposure to a portfolio of bonds whose interest rate payments adjust with prevailing interest rates. Expenses are 0.20%.
- Vanguard Growth ETF (VUT): For cheap exposure to a broad range of U.S. large-company growth stocks, it's hard to beat VUT, which sports a low expense ratio of just 0.06%.
- Financial Select Sector SPDR (XLF): For broad exposure to large-cap U.S. financial stocks involved in the banking, brokerage, and insurance industries, XLF is an outstanding choice. Expenses are 0.13%.
Investors should keep in mind that these interest rate ETFs can still lose value, even in a rising rate environment when they are expected to perform better than other types of ETFs. It's also smart to remember that a diversified portfolio typically consists of several funds from diverse categories. Investments that concentrate in one narrow part of the market should not receive allocations higher than 10% to 20% of your portfolio.
The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.