How to Profit from Higher Interest Rates with These Two Simple Investment Strategies

Guest Post by Investment Contrarians

One question that readers have asked me a lot lately is: how can they adjust their investment strategy to profit from higher interest rates? This is a great question, and to answer it, there are several strategies I would look into. 

The first investment strategy that immediately appears in my mind is to incorporate what’s called an inverse exchange-traded fund (ETF). 

An ETF is a product that trades like a stock, but comprises many different investments making it easy for the average person to enter and exit a position. An inverse ETF essentially moves in the opposite direction of the underlying assets. 

With interest rates moving higher, this means prices for bonds will be moving lower—interest rates move in the opposite direction of price. One investment strategy to profit from this rise in interest rates would be to use a product such as the ProShares Short 20+ Year Treasury (NYSEArca/TBF) ETF. 

Why would I incorporate a 20-year inverse ETF as part of this investment strategy? Because when interest rates rise, or fall, the further out in the future a bond matures, the greater the impact the rise in interest rates will have on price. 

There are some points to consider with this product, including the fact that this is a one-times the inverse ETF. What this means is that the goal for this ETF is to return, on a daily basis, the equivalent move in the opposite direction of long-term bonds. Also, if interest rates do not move and remain with very low volatility, this type of ETF can begin to erode their returns over time. 

The chart for the ProShares Short 20+ Year Treasury ETF is featured below:

Chart courtesy of www.StockCharts.com 

This chart shows both the performance of the ProShares Short 20+ Year Treasury ETF as well as the interest rates for 20-year bonds, which is the solid line. As one can see, they move closely in sync. 

One should be careful not to immediately rush out to add such a product. As you can see, going back over the past year, even though interest rates have risen, they don’t move in a straight line. Every time interest rates have risen, there has been some pullback along the way. 

I will say, however, that looking to add a product that can help you generate profits when interest rates rise is a good investment strategy over the next few years, in my opinion. As I stated many months ago when interest rates were much lower, I believe interest rates are set to move higher for a number of reasons, and one needs to incorporate this into their investment strategy. 

For those readers looking for another investment strategy to at least shelter their portfolio from higher interest rates, I would suggest looking at shorter timeframe notes as well as alternative products. 

As an example, featured below is the chart for the PowerShares Senior Loan Portfolio (NYSEArca/BKLN). Senior loans are interesting in that companies borrow under this structure through a floating rate, which adjusts over time. As interest rates move up, the rate paid by the company through the senior loan also moves up.

Chart courtesy of www.StockCharts.com 

As you can see, while senior loans do not move exactly in sync with interest rates from long-term bonds, when they are part of an investment strategy in a well diversified portfolio, senior loans can help spread out one’s risks. 

These are just a couple of ideas one can incorporate when coming up with an investment strategy for an environment in which interest rates are more than likely set to rise over the next few years.

~ by Sasha Cekerevac, BA 

This article was originally published at Investment Contrarians