Investing When Interest Rates Rise

[Mary Woods]

Since interest rates are at historical lows, it is probable that rates will increase in the long-term.

If that assumption is true, would it make sense to invest in the Profunds Rising Rate Opportunity Fund (RRPIX)?

 

[wabmester]

It doesn't look very appetizing to me. It looks like they use options to bet that long-term treasuries will drop. That's probably a good bet long-term, but options force you to pick *when* you think the drop will happen. They've obviously been wrong so far, and the fund is down something like 12%.

 

[johnblake]

I've been expecting rates to raise for years. As a result, I've stayed too short. Don't try to time the market. Diversify, and ladder your bonds.

 

[wabmester]

I've been expecting rates to raise for years.  As a result, I've stayed too short.  Don't try to time the market.  Diversify, and ladder your bonds.

Of course, it's high demand that is keeping rates low.  So, it's exactly this sort of capitulation that will cause rates to rise.   You can't win  

FWIW, I recently liquidated a large chunk of short-term bonds.   The spreads between corporate and treasuries are so thin that it makes no sense to hold short-term corp any longer.   And the negative spreads between munis and treasuries are so large, that it makes no sense to hold munis either.

There are quite a few short-term CDs out there yielding close to 3%, which beats just about every type of short-term bond right now.

And rather than extend my bond ladders with pitiful yields, I've been reluctantly buying high-dividend stocks.   Which is just what Greenspan wants me to do.  So, you can thank me for helping to prop up these rediculous stock prices  

 

[John Galt]

Interest rates are like the weather. We all talk about it. I am somewhat flummoxed right now as I've gone 100% long term/high yield bonds on my entire IRA. I have thought about switching it all back to CDs if rates went up
faster than my NAV eroded, but the IRA is doing well
and rates remain low. In the next 60 days I expect to
receive a big infusion of cash from some callable corporate
notes I have held for years. My broker says they will
be called for sure. Now, the IRA and the corp. notes
are my "forever" money. I will not need to touch the
initial investment. It just has to throw off the
maximum income. So, another big decision coming up.
It's sure better than not having any money to fuss
over though

John Galt

 

[charlie]

Hey John,

Vanguard's GNMA fund is currently paying 4.62%. It
has a good record, particularly in a rising interest rate
environment. It might be a good place to park your
long term money if you are waiting for long rates
to go up.....which might take a while.

Cheers,

Charlie

 

[cute fuzzy bunny]

Just read an interesting article on bonds.

Basically said to forget corporates due to the mentioned thin yields.

Skip high yield bonds as the dividend premium doesnt warrant the risk.

Skip I-bonds unless the interest rate is 2%+ (currently 1%).

Buy tips if you think inflation will rise and interest rates will stay tame.

Buy EE bonds if you think rates will rise but inflation will stay tame.

Pretty much all of which makes sense and makes me want to bang my head on the desk.

 

[ats5g]

TH,

Do you have a link to that article?

Thanks,
Alec

 

[brewer12345]

Just read an interesting article on bonds.

Basically said to forget corporates due to the mentioned thin yields.

Skip high yield bonds as the dividend premium doesnt warrant the risk.

Skip I-bonds unless the interest rate is 2%+ (currently 1%).

Buy tips if you think inflation will rise and interest rates will stay tame.

Buy EE bonds if you think rates will rise but inflation will stay tame.

Pretty much all of which makes sense and makes me want to bang my head on the desk.

Makes sense to me. That's why I have largely ignored fixed income investments lately, aside from the occasional high yield CD.

 

[MJ]

Pretty much all of which makes sense and makes me want to bang my head on the desk.

As much as I am excited to ER in 6 to 7 months, I am not looking forward to managing of my portfolio since I don't have a few million in the bank to live on.
I have to admire your courage in retiring as early as you did, and to boot, getting married and become a daddy.

MJ

 

[azanon]

Looking over a relatively long period of time, low interest rates have often been a bullish signal for stocks more than anything, but slightly less so once they start rising (but are still "low"). Traditionally, long-term bonds are avoided in rising interest rates though they seem to be doing decent here lately. Fixed income investments arn't real attractive with low interest rates (because.... duh.... interest rates are low).

 

[johnblake]

Interest rates are low and the market looks overvalued. I think I'll diversify!

Now I'm confused. I just went through my fixed income portfolio and decided to keep Vanguard ST Corp, and IT Muni. I pay 8% state tax and 27% fed tax

Vang fund: Rate - Fed Tax - STate Tax = effective yeild

STCorp: 2.93 - .79 - .23 = 1.91% (maturity 1.8 years)
STTeas: 2.44 - .65 - 0 = 1.79% (maturity 1.8 years)
ITMuni : 3.07 - 0 - .24 = 2.83% (maturity 4.7 years)
ITCorp: 4.21 - 1.13 - .33 = 2.75 (maturity 4.7 years)
2yrCD: 2.875 - .776 - .23 = 1.87%
5yrCD: 4.0 - 1.08 - .32 = 2.6%
I Bond: 3.39 - .91 - 0 = 2.48%
EE Bond: 2.84 - .767 - 0 = 2.07%

I Bonds and EE Bonds have some attractive benefits:
- interest accrues tax free until the bond is cashed.
- holding period is 5 to 30 years (can be cashed sooner with 3 mo. penality.)
- can be cashed tax free to pay for a childs education.
- rates are adjusted every 6 months.

I concluded that holding onto the ST Corp and IT Muni is reasonable given the spreads in interest rates.

 

[azanon]

Vang fund: Rate - Fed Tax - STate Tax = effective yeild

STCorp: 2.93 - .79 - .23 = 1.91% (maturity 1.8 years)
STTeas: 2.44 - .65 - 0 = 1.79% (maturity 1.8 years)
ITMuni : 3.07 - 0 - .24 = 2.83% (maturity 4.7 years)
ITCorp: 4.21 - 1.13 - .33 = 2.75 (maturity 4.7 years)
2yrCD: 2.875 - .776 - .23 = 1.87%
5yrCD: 4.0 - 1.08 - .32 = 2.6%
I Bond: 3.39 - .91 - 0 = 2.48%
EE Bond: 2.84 - .767 - 0 = 2.07%

Now just throw in inflation, and you should be right at 0% yield. Yipee!

Think i'll stick with stocks (but diversify too. Its not either/or)

 

[wabmester]

STCorp: 2.93 - .79 - .23  = 1.91% (maturity 1.8 years)
STTeas: 2.44 - .65 - 0     = 1.79% (maturity 1.8 years)
2yrCD: 2.875 - .776 - .23 = 1.87%

First, those are not maturities, they're durations.   Second, you're comparing SEC yields which don't necessarily tell you current conditions.

So, here's the data I used based on current yields:

2-Year treasury: 2.46%
2-Year AA corp: 2.55%
2-Year AA muni: 1.35%
1-Year IndyMac CD: 2.9% (several others in this range)

You're getting very little premium for taking on the risk associated with corporate dept.    You're taking a huge haircut for the tax-break on munis.   And you can get a higher yield from a CD with zero risk and shorter-term maturity.

 

[azanon]

I'm sure you guys know bonds better than i do since I only use them to offset my stock risk, but i've read (in multiple books) its hard to beat just a plain-jane, intermediate-term, investment grade bond fund (with a low expense ratio of course).  

I also like bond funds that mix in a little high-yield, but mitigate the risk such as Janus Flexible income (JAFIX).  Just that one fund would give you all the diversification you need, and a wonderful, "autopilot" return.  There are better ones than that, but its the one I use.

Easy portfolios are underrated, IMHO.  Having to manage individual securities cuts into my tennis time.

 

[johnblake]

Thanks for the clarification.

The thing I like about these Vanguard funds is that I can put my money there, and forget about it. These funds saved my ass in 2000-2003. I'd be working today if I didn't put a significant portion of my savings there.

I'm planning to move some $ over to CDs too.

I don't like these low yeilds, but I also don't want the risk associated with stocks. My stock allocation is around 50%.

 

[wabmester]

azanon, most of those books base their advice on historical results. I prefer predicting the future

An intermediate-term bond fund is fine as long as you're willing to suffer a hit and wait for as long as the average duration of the fund before you're whole again.

My short-term cash is looking for the highest yield possible while it sits on the sidelines looking for good investment opportunities.

 

[azanon]

azanon, most of those books base their advice on historical results.  I prefer predicting the future

Well, i know they say past performance doesn't equal future return, but it does beg the question:  What the hell else do you have to base the decision on?

Are the horseraces a fair analogy?  Which horse does the crowd usually think will win (and because of that, pays worse)?  Usually, its the horse and/or jockey that's won in the past.  As you say, those past events certainly dont predict the future, but I know where i'd place my bets if i had the advantage of hindsight, but wasnt penalized for having the advantage of hindsight (as you are at the horse track).

 

[wabmester]

Are the horseraces a fair analogy?

Fine. You're betting on a horse based on his past wins without considering how well he does in his current environment. Your horse is ready for the pasture.

What else can you consider? Fundamentals. The current interest rate and inflation environment. Demographic trends. Government policy. Economic trends. Risk of terrorism. Etc.

Granted, sometimes even well-founded predictions will be wrong. Sometimes unpredictable human behavior carries the most weight. But virtually any of these forward-looking factors I listed makes for better betting than looking exclusively at past performance.

But make your bets based on history as well. Just don't bet the farm.

 

[Cut-Throat]

I have never seen anyone or organization successfully predict the future in my lifetime.

Looking back on predictions that have been made throughout the last several decades  are laughable. I recall a predication made in the mid 70's that 'Gas Station attendent'  would be the fastest growing job. And they were correct in that we all are pumping our own gas - except the job pays nothing!

The one comfort that one can take in the stock market currently, is that almost no one thinks it is a good deal! All you can do is diversify and not get spooked. Easy to say and hard to do.

BTW - I read Harry Dent's book (something about the big boom of the 2000's)  - What a joke - His current forecast for he Dow would be about 18,000, headed to 30,000 around 2008-2010 - before the meltdown!

Does anyone here remember the Jerk Ravi Batra? The Princeton Professor that warned of the Great Depression of the 1990's?  - His followers took all their money out of the market and moved to the cabin in the woods, to wait out the calamity. Then they could buy cheap stocks while everyone else starved. I think ***** may have been one of them! He's still waiting to buy cheap stocks!

 

[retire@40]

It may make sense to invest in RRPIX in the long-term (4 to 5 years), but not in the short-term since the short-term anticipated increase in interest rates are probably already built into the current fund price.

A good strategy may be to invest now, hoping interest rates will rise higher and faster than anyone is now predicting, then when long-term treasury rates get to 7% or higher, cash out and invest in a long-term treasury index.

 

[wabmester]

I have never seen anyone or organization successfully predict the future in my lifetime.

Heh, and  all this time I thought you were the guy that was batting a 1000 with the "sun will come up tomorrow" prediction  

Here's how I use my amazing predictive powers:  I simply try to understand my investments well enough to get a good feel for what moves them, what risks are associated with them, and what best/worst-case returns might be.

I try to avoid investments with high risk and low upside.   I'll occasionly make investments with high risk and potentially high upside.   If I can't find enough "reasonable" investments for the amount of cash I have, I'll spread some of the cash across diverse so-so investments, and I'll hold some of the cash with the hope that better opportunities will come along.

Personally, I find this more fun than following the doctrine of the day, but I'll be the first to admit that there's a lot that I know that I don't know and even more that I don't know that I don't know  

 

[johnblake]

What else can you consider? Fundamentals. The current interest rate and inflation environment. Demographic trends. Government policy. Economic trends. Risk of terrorism. Etc.

But these are the things that all the 'experts' consider. These factors are already included in the price of the stock and bond markets and in current yeilds.

Have you tested your ability to time the market over a reasonable time period using objective measures?

 

[ats5g]

okay let's talk about the current investing environment. The stock market's expected return is around 3-3.5% (1.5% dividend + 1-1.5% real received growth), and long term TIPS are currently yield around 2.15% (?). hmmmm... not much of a risk premium there is it? Is the expected return of value and higher dividend paying stocks that much higher that the stock market? Perhaps 1% or so. We're certainly not even close to the risk premiums of early last century.

Just b/c interest rates are low doesn't mean that they have to go up anytime soon. Interest rates, and bond returns, have not mean reverted.

Also, rising interest rates affect everything - bonds, stocks, REITs, etc.. Look at the interest rate increases in the last 20 years - 1999, 1994, and 1997. Value stocks did worse than blend and growth, and value stocks did worse than intermediate bonds! Now, I'm not saying that value stocks, or high dividend paying stocks will do badly during the next time of interest rate increases, but thinking that they're some sort of safe haven is just plain wrong. They could be, or they could not be, we just don't know.

Also, thinking that GNMA's may be safer could also be wrong. How did they do in the late 1970's or early 1980's, during periods of very volatile interest rates?

Two articles from Vanguard:

PlainTalk bulletin addresses bond investor concerns

Understanding bonds and interest rates

- Alec

 

[wabmester]

But these are the things that all the 'experts' consider.  These factors are already included in the price of the stock and bond markets and in current yeilds.

I believe that the current price of a security is set by the dollar-weighted "experts" out there, but that doesn't mean that there's consensus or that the net weighting of factors is aligned with my interests. If all of the experts were ER's with a 50-year investment horizon, I'd feel much better about betting on market efficiency.

Have you tested your ability to time the market over a reasonable time period using objective measures?

I haven't tracked my investments very well over the past 20 years, but given my net worth today, I know my average rate of return was over 20% a year. Of course, that tells you nothing about how I got there, how consistent I was, and certainly has no value in predicting my future returns.

I'm not trying to beat benchmarks. I'm trying to stay retired. That means I'm probably overly-sensitive to downside risk, and that type of risk is often masked by historical returns.