June 4, 2010, 7:31 am

Fight the Rise in Interest Rates With Your Portfolio

by: The Financial Blogger    Category: Investing Ideas,Investment, Market and Risk
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As announced last Tuesday, The Bank of Canada had increased its interest rate by .25%. While this is not catastrophic (it’s even good news to finally signal the exit  from this recession!), the rise in interest rates also comes with the fear of having inflation take over. As an investor, how do interest rates and inflation affect your investments?

Well while inflation will negate (or neccessitate) part of your yield (we have no control over it!), the increase in interest rates will negatively affect the market value of your bonds and will also influence your other asset classes.

Stock market: always a winner

When there is an increase in interest rates, this is usually a good sign for the stock market. At first, nobody on the Street (Bay or Wall Street for that matter) will be happy to see the interest rates on the rise. In fact, the markets will probably react negatively on speculation about a change in interest rates. However, if the rate go up, this means that the economy is doing well. Therefore, companies will show improved results and this is when the stock markets will star as the darlings at the dance.

As stocks grow faster than inflation, having a good portion of your money invested in the market remains the right thing to do.

Gold… not good..

As gold is known to be the perfect place for investors when they are afraid of the market, this is probably one of the worst places to invest your money when the investors regain confidence in the markets.

Historical stats show 2 things about gold:

#1 It demonsrates high volatility

#2 It doesn’t outperform inflation

This is why I am not a big fan of gold. I would rather buy gold mining companies or have a resources mutual fund (or ETF) that regroups companies working in the gold industry than buying the metal directly.

Money Market: get rid of it!

If there are people still parked in the money markets, they are really missing a great story. For those waiting for the big comeback of high short-term interest rates hear this: it’s not on the radar for at least another year. Therefore, the worst place to stash your money is definitely in the money market! When you think that ING is giving 1.2% right now… it doesn’t even cover inflation (and I am not even talk about after tax yield!).

Bonds; real rate interest bonds are the solution

If you want to stay in a secure investment area, I suggest you use your track investment apps to find real rate interest bonds. You can also use the investment services from your bank to establish a bond ladder so you will be covered against interest rate increases.

The problem if you don’t have a bond ladder is that you will always be tempted to play the interest rate markets. Trying to determine when it is the “right time” to invest and freeze all your money into a “good” rate. Don’t be a rate rat; invest intelligently.

And if you really don’t want to bother about interest rates and inflation, just go with real rate interest bonds that will track inflation. By keeping them to maturity, you will also avoid losing value due to an interest rate increase 😉

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Comments

Ok, my question is how would you go about buying these real return bonds? Through ETF’s or buying the actual bonds? How much of the bonds do you need for the actual cost to be worth it?

If Gold is the true inflation hedge, then why would you buy a miner? The miner would be affected if the turned sour because of inflation, no?

by: The Financial Blogger | June 4th, 2010 (10:47 am)

@ BMSP
In an inflation environment, Gold should maintain its “real value”, so the Gold Miners should be among the companies that would do well in such a context

@ IS
if you want to benefit from the ajusted rate, I’d go with a bond ladder through a broker.

I’m not quite sure how much you would need but this product would be very relevant if you do not trade large amount (what is 2% on $10,000 anyway…)

Hi TFB,

Doesn’t your description of “rate rats” run counter to your own actions when it came to finding financing (http://www.thefinancialblogger.com/1-99-balance-transfe-credit-card/), where you write “This is why I ran through internet listings to look for the lowest interest rate…”

I realize that you were speaking of deposits with your comments about rate rats, while your actions had to do with loans, but the result is the same: a better return for your money. A lender might make the same arguments you did as an advisor, i.e. that it is better to form a relationship with your lender/advisor so that overall he can give you a better long-term deal, and that rate shopping doesn’t do that.

So my question is, how are you drawing the distinction here between what you wrote about rate rats and what you just did about finding a source of your own financing?

by: The Financial Blogger | June 4th, 2010 (1:51 pm)

@ Saj,

Pretty good point on the surface, but let’s dig a little further.

If you are looking for a specific product for a specific need and you know exactly what you need, then I guess you can be a rate rat (on both investing or financing side). However, the reality is that most people THINK they know what is good for them and tend to manage their own finance with one thing in mind “what is the best rate”.

When you transfer a credit card over, all you need is a rate. There is not much to talk about. However, if you are thinking about a mortgage or an investing strategy, several things come into play (your projets, your risk tolerance, you liquidity needs, etc.). If you are simply looking to put your money aside for 6 months because your are buying a house, for sure that you can play the rate rat. There is not much advice to give anyway 😉 But if you have 20K to invest for your retirement, then looking for the best rate won’t necessarily answer your needs.

As a financial planner, I have more chance to know what I need for my own personal finance (the same way a mecanic knows best what is good for his car or a computer tech how to repair its computer). So for specific and simple need, you don’t need advice. However, for more complex issues (i.e. retirement planning, buying a house, tax planning ,etc.) not seeking for financial advices will definitely hurt you.

thx for bringing this point 🙂

Couldn’t agree more:
“…stocks grow faster than inflation, (so) having a good portion of your money invested in the market remains the right thing to do.” Well said.

Hi TFB,

Okay thanks for your response. So I guess the distinguishing characteristic you use is that rate-shoppers should be people who don’t need financial advice (i.e. they are already financially astute, or it is a simple situation).

by: The Financial Blogger | June 7th, 2010 (2:28 pm)

@ Saj,

exactly, if you are not sure if you need advice or not, then just meet with a financial advisor, expose your situation and listen to what he has to tell you.

Don’t talk about rate and concentrate on different strategies. if he only offer you a plain 5 year mtg or 5year CD’s then go elsewhere or go shopping because this is not a financial advice, it’s a financial order that he is delivering 😉 We are supposed to be more than a pizza delivering guy!

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