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How investors can get ready for the first rate hike

Interest rates are surely going to rise; it isn't a matter of "if" anymore but merely a matter of "when."

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Investors may believe that they want to exit the stock market in anticipation of rising interest rates, preferring to commit funds to the "safer" bond market. In more normal market conditions, that would be a prudent strategy. Today, however, I believe that there is more risk in the bond markets than in the stock market.

The bond market is largely about mathematics. There is an inverse relationship between bond prices and interest rates. When rates rise, bond prices fall. With rates at historical lows, there is only one direction for interest rates to trend and that is upward.


So, what is a bond investor to do? I would strongly urge investors to shorten the duration (term to maturity) of their bond portfolios. There isn't enough difference in yield to compensate investors forbearing the higher risk of longer-term bonds vis-à-vis short-term bonds. While the return on short-term bonds is negligible,investors will protect principal value — and, that principal can likely be invested at higher rates in coming years.

As for equity investors, they should temper their expectations as returns tend to be lower in a rate-hiking cycle. From 1966 through 2013, the S&P 500 returned 15.2 percent in falling rate environments and only 5.9 percent in rising rate environments.

There are some sectors that perform better when rates are rising, such as energy, consumer goods, utilities and food stocks. On the other hand, autos, durable goods, and retail stocks have performed abysmally when rates were rising.

In general, equity investors with a long time horizon shouldn't concern themselves with the short-term actions of the nation's central bank. Investors with a long time horizon should be largely concentrated in equities and understand that some market periods are more lucrative than others.


Commentary by Robert R. Johnson, president and CEO of The American College of Financial Services, a non-profit, accredited, degree-granting institution in Bryn Mawr, Pa. He is also co-author of "Invest with the Fed" (2015). Follow him on Twitter @BobAmericanColl.