Investors can be shaken up as the New Year approaches, and rightly so.
Even as the omicron Covid variant leads to a new wave of infections, the Federal Reserve’s easy money policies are coming to an end.
For months, various inflation reports hit their highest levels in decades. The Consumer Price Index, which measures the cost of a large basket of goods and services, jumped 6.8% year over year, the fastest rate since June 1982.
In response, the central bank has indicated it will take aggressive policy action, with Fed officials seeing up to three rate hikes this year, two more next year and two more in 2024.
“It’s written on the wall that interest rates are set to rise in 2022, but don’t let that cloud the big picture – that the economy is expanding, unemployment is rising. decline and that corporate profits are expected to rise, ”said Greg. McBride, Chief Financial Analyst at Bankrate.com.
“People are terrified because they see interest rates going up,” added Daniel Milan, managing partner of Cornerstone Financial Services in Southfield, Michigan. “But, from an investment perspective, interest rates rise when the economy is generally doing well.”
“People are spending,” he added. “If you look at it from another perspective, it means positive things are happening.”
To take advantage of the current climate, Milan advises its clients to make four key changes to their portfolios. Here are its main recommendations:
Avoid longer term fixed income assets: Generally, treasury bills lose value over time if the interest they earn is below the rate of inflation. Currently, the 10-year benchmark is earning around 1.62%.
“If you plan to have bonds in your portfolio, we recommend short-term bond funds until interest rates rise,” Milan said. “They are going to be less risky in an environment of rising rates.”
While short-term bond funds are less sensitive to rate hikes, they also offer less income potential.
Nonetheless, they will add some stability when the stock markets are volatile, McBride said. “Even though the market is doing well this year, the race is likely to be bumpy along the way.
“It’s during this bumpy race, you’ll be happy to have some bond money,” he said.
Find a floating rate: Bond funds that adjust for inflation are another way to mitigate risk.
For investors looking to divide a portion of their portfolio – say, one to three years of retirement income – into a less volatile investment that will keep pace with current inflation, a floating rate exchange traded bond fund. may be appropriate, said Katelyn Murray, certified financial planner at Kendall Capital in Rockville, Maryland.
“These ETFs are conservative like a bond, trade like a stock, and diversify like a mutual fund,” she said.
Milan recommends floating rate bond ETFs like the iShares Floating Rate or Market Vectors Investment Grade Floating Rate, which include investment grade corporate bonds and are less exposed to interest rate risk over time.
However, “you don’t want to be too conservative and miss out on the appreciation you can get in the stock market,” Murray added. “You also need long-term growth.”
Look for stocks with dividend growth: To that end, companies that are well positioned to cope with higher prices and have a history of consistent dividend payments are also good assets to own when interest rates rise.
Milan recommends large-cap commodities, like Home Depot, Lowe’s, and PepsiCo, for example, which have a habit of increasing dividends year over year.
“It’s both a hedge against inflation and a yield that bonds don’t currently offer,” he said.
Focus on the financial sector. Financial stocks generally benefit from a strong economy and higher rates, as banks can charge borrowers more, while paying depositors less.
“As rates go up, the financial sector is doing quite well,” Milan said, especially stocks like PNC Financial Services or ETFs like First Trust, he added. (Experts say international equities, utilities, healthcare, consumer staples and real estate investment trusts could also outperform the broader market in 2022.)
“Does this mean that you are radically changing your approach?” Not necessarily, ”said CFP Douglas Boneparth, president of Bone Fide Wealth in New York.
“Financial services are generally attractive, but there is a danger in always saying that will happen,” he warned.
“If the rate hike doesn’t materialize as you thought, you could end up underperforming.”
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