Investing Advice: The Risk of Rising Rates

Posted On April 10, 2018 1:29 pm

This morning’s data showed that inflation is picking up at its fastest pace over two years and is on pace to hit the Fed’s 3% target. This means the Fed is likely to adhere to its planned pace for 3 more interest rate increases this year. Today’s investing advice explains the implications of these rate hikes.

Investors have been worrying about a rising rate environment for a few years now. What would it do to their bonds, and how would a normalization in rates affect stocks? The jury is still out, but so far so good.

From July 2016 through February 2018, the ten-year treasury rate rose from 1.37% to 2.94%. Over this 19 month period, a broad basket of bonds (BND) fell 2.13%. Fortunately, stocks more than made up for this, rising 33% over the same time. Since rates began their ascent in February 2016, a 60/40 portfolio rose 19%, or 11.7% on an annualized basis.

Bonds fell 2% over the past nineteen months; Stocks fell 2% four times in the past twelve sessions.

The chart below shows the rolling 30-day standard deviation of a 60/40 portfolio broken down between stocks and bonds. Over the past 20 years, 86% of the volatility of a 60/40 portfolio has come from stocks.

Also, the reality is that the current situation is a boon for most long term investors. For those who need a balanced portfolio with some fixed income, they should be cheering for higher rates in order for the bond portion of their holdings to generate income.

While there might be a short-term drop in the value of both stocks and bonds, over the long term higher rates will lead to higher returns. The best investing advice for traders right now is to focus on the long haul, and make choices that take advantage of coming rate hikes.

 Related: How to Navigate a Stock Market in Transition

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Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.

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