What are the best investments when interest rates are rising? Market timing is tricky at any point in time. However, there are some smart moves you can make to invest in the best stock funds and sectors in a rising interest rate environment.
When interest rates are at or near historical lows, it is wise to prepare for the rates to rise. This is often followed by a final move upward for stocks before a decline (bear market) ensues. The economy may be fairly healthy when rates begin rising, but rising rates signal the start of the end of an economic cycle.
One balanced approach when interest rates are rising is to stay invested and take advantage of late-stage positive momentum, but you should also prepare for harder times that are lurking around the corner. Take a look at the best stock funds and stock sectors for rising interest rates.
Best Stock Funds for Rising Interest Rates
If you choose to invest in mutual funds when rates are rising, you have to know which mutual fund categories can work for you.
One such type is growth stock funds. These mutual funds are focused on growth stocks, which have strong projected growth and attractive return on equity. The best time to invest in growth stocks is usually when times are good, during the latter (mature) stages of an economic cycle.
Times of rapid growth often occur at the same time as rising interest rates. Momentum investing takes advantage of this. For instance, in 2007, the economy was growing rapidly, and most market indexes had reached all-time highs. It was at that time that growth stocks dominated across all capitalizations—large-cap stocks, mid-cap stocks, and small-cap stocks. Note that 2007 was the year prior to the Great Recession of 2008, which ended the cycle.
Keep in mind that growth stocks and growth stock mutual funds often see bigger declines than the broader market once a bear market correction begins.
Best Stock Sectors for Rising Interest Rates
When interest rates are on the rise, the economy is typically nearing a peak, because the Federal Reserve raises rates when the economy appears to be growing too fast. Thus, inflation becomes a concern.
Those who aim to time the market with sectors will have the goal of catching positive returns on the upside. At the same time, they'll want to prepare for harder declines when the market turns down.
You may want to consider sectors that tend to perform best (or fall in price the least) when the market takes a downward turn. These can be considered defensive investment types:
- Consumer staples (non-cyclicals): Consumer discretionary (cyclical) stocks will typically perform best during the peak times of the economic cycle and during the early stages of rising interest rates. But non-cyclical or defensive stocks are more suitable before a recession hits, which is difficult to forecast. People still need housing, food, heating, cooling, education, and products for daily living, even during a recession.
- Healthcare: Just like staples, people still need to buy their medicine and go to the doctor in both good times and bad. Health sector mutual funds and ETFs can be smart holdings when rates are rising.
- Gold: When traders expect an economic slowdown, they tend to move into funds that invest in real, physical asset types. These funds may include assets such as gold funds and ETFs. Gold is not a sector, but it is an asset that can do well in uncertain times and falling markets.
The chart below shows the gold fixing price per troy ounce from 2000 through today.
The Bottom Line
Even though you are striving to make smart purchases, you must use caution. Be aware that market timing is not a good idea for most investors. However, you can still use some of these ideas when constructing your portfolio to help you diversify.
Frequently Asked Questions (FAQs)
Why do rising interest rates generally depress stock prices?
When interest rates rise, there are ripple effects in the broader economy. They affect stock prices, because the cost of lending goes up, which drives down business growth and expansion. Rate hikes also drive investors toward investments with lower interest rates and a guarantee of delivering returns, which reduces demand for stocks and pushes prices down.
Should I invest in bond funds when interest rates are rising?
Bond funds behave similarly to stocks in an environment of rising interest rates. As rates rise, bond prices drop, especially on long-term bonds. That is why many investors will rush to buy short- or intermediate-term bonds, expecting that rates may continue to rise on long-term bonds. Treasury inflation-protected securities (TIPS) make another good bond investment when interest rates are on the rise.