How to Invest When Interest Rates Rise

All right, so look at this graph. Interest rates in the United States from 2009 to 2017 were virtually zero, but you can see it's starting to tick up right now, back to similar rates before the Great Recession. Interest rates continue to go up, and the Fed and the Bank of England both raised their rates 0.75% or 75 basis points very recently. With another interest rate hike planned for this year, as well as many into 2023, we are beginning to wonder what investments and what investing could look like in a higher rate environment. So even if you're not from the United States, your country likely has a central bank, and they are going to be tinkering with their borrowing rates as part of their monetary policy. So in today's video, we're gonna discuss how interest rates affect your investments, how you can invest during a higher interest rate period, as well as I'm gonna share with you guys what I'm personally doing. So let's start with actually an overview of interest rates. Now, when I say interest rates, in the United States, we're generally referring to what's called the federal funds rate. So this rate is determined by our central bank committee. Right now, they meet eight times a year, and their goal is basically to ensure that the United States' monetary supply doesn't grow too quickly, causing inflation, but it doesn't shrink too quickly either. And one of the tools that central banks have to control monetary supply is to increase interest rates or borrowing rates, and because inflation has been so rampant this year, a lot of central banks are starting to increase their interest rates. When interest rates are low, banks will lend money to other banks at a low interest rate, and in turn, those banks will lend their customers money at a very low interest rate as well. Also, when these rates are so low, the banks aren't really offering you a great interest rate on your money, so basically what that means is that instead of keeping your cash at the bank, you're more likely to spend that money in the economy, stimulating the economy, and having money move around more and more. Interest rates affect spending behavior, and let me give you a simple example. Let's pretend that you wanna borrow $100 from your friend so that you can go buy a pair of Nike shoes. He agrees and says, sure, I'll lend you the $100 as long as you pay me back $101 at the end of the year. And you're thinking to yourself, man, that's a pretty good deal. All I have to do is owe him one extra dollar for the entire year of owning that $100. That's only 1%, that's pretty good. So you borrow that $100 from your friend, you pay him back the extra dollar that he requests, and you go on your way. That dollar is pretty negligible. But now let's pretend the situation completely shifts on its head. Let's pretend that your friend wants $20 back at the end of a year, effectively making the interest rate 20%. Now all of a sudden, you're rethinking your choice. Do you really wanna buy those Nikes if you know that you have to owe your friend $120, an extra 20 at the end of a year? So when the interest rate was low 1%, you had no problem borrowing and spending that money. But when the interest rate became 20%, all of a sudden you were like, oh my God, I don't think I wanna buy these shoes. And that's exactly how spending behavior happens in our economy and exactly what's going on right now. All right, so back to the interest rate graph, you can see that the federal funds rate has varied widely over the years. It was set to as high as 20% in the 1980s in response to inflation. During the Great Recession of 2007 to 2009, rates were slashed to 0% to 0.25% in an attempt to encourage growth. Now the 2010s were largely characterized by this low interest rate environment and subsequently one of the biggest bull runs in the market happened to take place. But now things are changing. The federal funds rate currently sits at between 3.75 to 4%. Their 2023 target, the Federal Reserve has said, is between five to 6%. Now when these interest rate changes happen, that actually affects the way that companies perform in the market. It changes the bond market, it'll change mortgage rates, which will in turn affect the housing market and it even affects your car loan rate. So what are some of the better investments to make in a growing interest rate environment? While past performance is not indicative of what's gonna happen in the future, we can still look to the past to see what has happened in the past when interest rates are high. Rising rates are typically not great for growth stocks because growth stocks tend to borrow a lot of money and the cost to borrow just went up. Many years ago, I discovered that since a lot of growth stocks are unprofitable, they highly leverage borrowing and debt. As interest rates rise and the cost to borrow increases, they're not able to take on more cash as quickly and that's going to affect their future valuation and in turn also affects their future cash flows, which may negatively impact their stock price. Now certain industries will do better in a rising rate environment and those industries include consumer staples as well as financial stocks, they tend to do well or any other stocks that don't rely on economic growth tend to do well as well. Now, in fact, we can already see this happening in our stock market right now. For example, one of my friends, Larry Chung here on YouTube has actually done some analysis on what has happened so far this year and I'm gonna share with you what he found. He noticed that three of the top 10 stocks in the S&P 500 are currently healthcare related or energy related. And today that index is heavily more weighted into energy, healthcare, financials and staples, but last year was a very different story. Last year, if you remember the S&P 500, 25% of it was made of tech stocks. Now don't get me wrong, tech stocks still kind of dominate the top 10 of the S&P 500 but meta, for example, has dropped down to the 20s region. In other words, according to Larry, the S&P 500 has recalibrated to the high inflation environment and is a lot stronger now that the companies that are heavily impacted by high inflation are now loosening its grip on the index's move. So one method to invest is to dollar cost average into a value ETF or value stocks that should benefit from this higher interest rate environment, for example, Vanguard's value ETF VTV, which is mostly comprised of healthcare, financials, consumer staples and industrial stocks. Now I do wanna point out while gross stocks might suffer, it doesn't mean the entire stock market is gonna suffer as interest rates rise. In fact, there's really not a guideline on when interest rates are high, the stock market does bad or when interest rates are low, the stock market does good. Even in periods of higher rates, the market has continued to trend upwards since the 1950s. So according to the Dow Jones Market Data Center, they actually recently analyzed the five most recent rate hike cycles and they've actually done some analysis on how stocks perform. You can see that the three leading stock market indexes only declined during one rate hike cycle, but rose in all other cycles. Overall, the conclusion is that higher interest rates can affect growth and tech stocks negatively, but other industries could benefit from it. The economy is not the stock market and vice versa, and there are many factors that contribute to the stock market prices, such as demand and inflation, but at least the data is showing us that even with higher rates, the stock market can grow at the same time. Now, this would be a really good time to grab some free stocks with the link down in description below. Webull is offering between seven and 12 free stocks when you sign up and deposit just a single cent. So that's seriously it, you don't have to do anything else, but if you use that link down in description below, that's when you'll get your free stocks. And as long as the link is in the description, the promotion will be active. So make sure you grab those, but let's actually talk about one of the main asset classes affected by interest rates, and that is real estate. Because interest rates affect mortgage rates via the 10-year treasury, mortgage rates have been going up tremendously, and recently they shot through the 7% barrier, and honestly, they could go a lot higher. With higher mortgage rates, it means that if you are financing a property over 30 years using a mortgage, it's going to be a lot more costly on a month-to-month basis, and many Americans finance their homes. For example, on a $500,000 home and an interest rate of 3%, and if you make a 20% down payment, the monthly payment would have been 16.86 per month on a 30-year fixed mortgage. Nowadays, with mortgage rates closer to 7.5%, that same monthly payment will only buy you a home that's worth $301,000. That's a 40% difference. So what does this all mean? It means that demand for housing should come down because as interest rates rise, more people can't afford homes, and if more people can't afford homes, then the demand of them is going to fall. If you are someone who's in a good position with some cash on hand, what you could do is wait for prices to come down, swoop in on a property, and then just refinance later when the rates come back down. However, if you are expecting rates to continue from here and stay elevated, then you might want to wait just a little bit longer, and me personally, I think rates are going to continue to climb for the next six to nine months. Now, when it comes to bonds, when interest rates rise, new bonds get issued with a higher yield than before. That means if you're an investor holding a bond, your interest payments will be larger. In order for an older bond with a lower coupon rate or yield to be attractive to investors, the price of that bond needs to come down as interest rates go up. Longer-term bonds, such as the 10-year US Treasury, are less affected than short-term bonds by the Fed's actions. Short-term bonds, like the three-month Treasury, might be worth looking into right now, as it's currently yielding 4.1%-ish, while the 10-year Treasury is only yielding 4.09%. Fixed-income assets like bonds are really good for conservative or older investors because they basically balance out your portfolio risk. Another good investment that you can make when interest rates are starting to rise is to actually pay down debt, especially credit card rate debt, which is tied to the interest rate. Now, this is especially true if you have at least $5,000 of credit card debt, if you're watching this video. Now might be a really good time to start prioritizing that over anything else. Credit card rates are getting higher and higher, and as of this past month, the average credit card APR in the entire United States is 18%, according to Bankrate. Now, if you pay off debt that is set at an 18% rate, that is basically like getting an 18% guaranteed return in the market because your dollar is getting a lot of value for paying that debt off. It's one of the best things that you can do with your money if you have debt is to get that guaranteed 18%. And by the way, that 18% is after tax. So if you were to try to beat that 18% pre-tax, it's even harder. Now, for those of you that have a lot of cash sitting around you've probably noticed that in the past few years, saving accounts haven't been paying that much interest for keeping your cash at the bank. In fact, I think the national average is something around 0.17%, which means that it's not really incentivizing you to keep your cash in the bank account and rather incentivizing you to spend it. That is changing now though, because one of the biggest benefits of interest rates rising is that actually saving is becoming more viable as some cash accounts and some high yield cash savings accounts are starting to offer a decent interest rate. So that means if you're a saver, you can finally get something for your money rather than the measly 0.1 or 0.2% that banks typically offered in the past few years. For example, some places like Wealthfront and other high yield savings account places have increased their cash APY to three to 3.3%. Banks will earn more money as interest rates go up and part of some of their strategies is to actually pass some of those savings along to you in the hopes that you try out their other products. So this is what you see happening right now and other banks offering high yield savings accounts include SoFi, Marcus by Golden Sacks, as well as Ally Bank. Just make sure you choose an account that has FDIC insurance, as well as an account that doesn't charge you for moving money. These high yield savings accounts are pretty good if you just have an emergency fund that you're putting in cash and you'd rather earn some money on it than nothing. So try that out. All right, so now let's get into what I'm doing and this will probably shock you because my strategy is pretty dead simple. The first thing I'm doing is I'm using this opportunity to get that cash 3.3% APY for my cash that's sitting in my checking and savings accounts. For example, my emergency fund and the bank account that I use for expenses, I'm gonna throw some of that cash into a higher cash APY account. If you have excess cash, you can do what I'm doing or you can buy a three-month treasury, which is currently yielding around 4.1% over three months as I talked about earlier. The other option you can do if you have a ton of excess cash is you could look into the Series I savings bonds. Those are from the treasury and they currently pay a modest 6.89% for the next six months. And those, if you'll remember, have an investment cap of $10,000 and you must hold them for at least one year. For my stock portfolio, I'm not super worried right now because I have a super long-term mindset and I'm gonna continue dollar-cost averaging into the index funds I like with the intention of holding them for at least 20 more years. I have a strong dividend portfolio as well and my largest holding is JP Morgan, which has been benefiting from the higher interest rate environment, so that's pretty great. My general strategy is that I'm not trying to catch falling knives when it comes to buying stocks, so I'm rarely buying after a one-day sell-off and I feel like it's so hard to call stocks when they're at the bottom. And that's why I think dollar-cost averaging is the best for my success. I am just an average investor, so I'd rather just put money away into the stock market and see it grow over time. Now, in terms of buying a home, which I want to do this year, I'm gonna see what happens in the next six to nine months as I think rates are gonna continue to be elevated, which means home prices could come down even further. Maybe then I can think about pulling the trigger on buying a home and then just refinancing shortly after that if rates come down. Let me know what you're thinking of doing while the interest rates are high and thank you for watching this video. Make sure you grab your free stocks down below, subscribe to the channel, and I'll see you guys all in the next one. All right, peace.