Rising interest rates require strategic approach

After decreasing rates 13 times from January 2001 through June 2003, the Fed began raising interest rates in 2004, and it appears this trend will continue. From your credit card debt to your mortgage, as well as your investments, higher interest rates can take a big bite out of your personal finances if you are not prepared.
Below are some helpful tips for dealing with rising interest rates and suggested steps you can take now to protect yourself.

Monitor your mortgage
It is important to keep an eye on your mortgage options during an economy of interest rate hikes. For example, if you have a one-month adjustable rate mortgage, you may notice that your monthly mortgage payments will increase during any rate hikes, while a longer term ARM will only adjust after the fixed portion of the ARM has expired.
For example, a five-year ARM will remain fixed for five years and then begin to adjust in the sixth year. If the fixed portion of your ARM is expiring soon, and you are planning on staying in this home for a long time, now may be a good time to consider switching to a long-term, fixed-rate mortgage. With an FRM, you will be paying a slightly higher interest rate, but the rate will be capped so it will not change for the length of the loan, which could be as long as 30 years.

Ladder your portfolio
As rate increases become a reality, you will notice that bond prices may suffer. The reason is that most investors don’t want to pay full price for existing bonds when they can buy new ones that pay a higher rate. Yet, just because the bond market is taking a hit, it does not mean you should abandon your bond investments. Bonds are still an important part of a well-diversified portfolio.
Instead, you should consider laddering your bond portfolio. In a nutshell, laddering is a strategy whereby you purchase bonds with varying maturity rates. This prevents all your money from being locked into longer-term, lower-yielding bonds. By laddering as your short-term bonds mature, you can reinvest in long-term bonds as interest rates increase. You can also practice the same laddering strategy with your certificates of deposit.

Invest in quality stocks
When choosing stocks for your portfolio, it is important to look at the company as a whole. Before investing in a company, ask these key questions: Is the company’s profit increasing each year? Are the company’s products in demand? How has this company fared during past interest rate hikes?
Typically, long-standing, quality companies tend to prosper during an improving economy and fare better than most during an economy with increasing interest rates.

Float your investments
Managing your portfolio requires proactive investing, especially in a rising-rate economy. Investing in floating rate funds is another way to combat increasing interest rates.
Because floating rate funds invest largely in fixed-rate corporate bonds and reset their interest rates every 30 to 90 days, they are less sensitive to interest rate fluctuations. They also tend to be less volatile and have traditionally offered impressive trade-offs between risk and return.
Floating rate funds can be a good idea in a slowly rising interest rate environment, such as the one we are in today, and have historically offered an attractive income stream.

Consider nonpublicly traded REITs
Nonpublicly traded real estate investment trusts can also be excellent investing tools in times of rising interest rates and have also traditionally yielded steady and impressive dividends.
When considering publicly traded versus nonpublicly traded REITs in a rising-interest-rate economy, note that publicly traded REITs are traded daily and fluctuate with the market, while nonpublicly traded REITs are not susceptible to short-term interest rate fluctuations and therefore tend to remain more stable.

Seek help
In a rising interest rate economy, there are many steps consumers can take to protect their personal finances. Choosing which of these many options are right for you can be tricky and confusing. Meeting with a qualified financial adviser can help you build a comprehensive financial plan as well as an investment strategy and portfolio specifically designed to suit your needs.
The preceding article is provided for informational purposes only. The information is intended to be generic in nature and should not be applied or relied upon in any particular situation without the advice of your tax, legal and/or financial adviser. The views expressed may not be suitable for every situation.

Paula Dougherty, ChFC, CLU, MBA, is a certified financial planner with American Express Financial Advisors Inc., member NASD. American Express Co. is separate from American Express Financial Advisors Inc. and is not a broker-dealer.