Sometime in the next 12 to 20 months (or even sooner), we’re looking at the very real possibility of interest rate hikes. If you’re caught off guard and holding the wrong exchange traded funds (ETFs), it could wind up being costly.
What goes down must eventually come back up, right? The rock-bottom interest rates we’ve been enjoying for the last few years aren’t going to last forever. They won’t be as necessary to help goad an economic recovery, so as the picture brightens both here and around the world, they’ll naturally have to go back up.
The catch for you, dear investors, is that bond prices share an inverse relationship with interest rates. As rates rise, the price of bonds fall. If you’re holding bonds with the intent to sell them sooner rather than later, this will impact you in the form of lost principal. This is why many investors take a “laddered” approach to bond investing and buy bonds of varying maturities, in order to mitigate interest rate risk.
- PowerShares DB U.S. Dollar Bullish (NYSEARCA:UUP)
- iShares Barclays 1-3 Year Treasury Bond (NYSEARCA:SHY): Short-term bonds tend to come in favor as interest rates rise and hit long-term bond prices
- United States Oil (NYSEARCA:USO): When interest rates rise, the dollar tends to weaken, which puts various commodities priced in dollars – such as oil – back in favor
- ProShares UltraShort 20+ Treasury (NYSEARCA:TBT) and Direxion Daily 30-Year Treasury Bear 3x (NYSEARCA:TMV): Long-term Treasuries will be hit the hardest when interest rates are hiked. For the risk-hungry among you, consider shorting long-term Treasuries. Before doing so, though, understand how these funds work!
Full disclosure: Tom Lydon’s clients own shares of SHY.