One balanced approach when interest rates are rising is to stay invested and take advantage of late-stage positive momentum, but you should also prepare for harder times that are lurking around the corner. Take a look at the best stock funds and stock sectors when interest rates go up.
Best Stock Funds for Rising Interest Rates
If you choose to invest in mutual funds when rates are rising, you have to know which mutual fund categories can work for you. One such type is growth stock funds. These mutual funds are focused on growth stocks, which have strong projected growth and attractive return on equity. The best time to invest in growth stocks is usually when times are good, during the latter (mature) stages of an economic cycle. Times of rapid growth often occur at the same time as rising interest rates. Momentum investing takes advantage of this. For instance, between 2009 and 2020, the economy was growing rapidly and the S&P 500, a barometer for the U.S. stock markets, experienced one of its longest bull markets ever. During this period, momentum investors, measured by the MSCI Momentum Index, saw positive returns in all years except 2018. The index generated 10-year annualized returns of 14.19%, with calendar year returns as high as 37% in 2017. However, between Jan.-Oct. 2022, the index delivered a -17% return amid broader stock market turmoil.
Best Stock Sectors for Rising Interest Rates
When interest rates are on the rise, the economy is typically nearing a peak. This is because the Federal Reserve raises rates when the economy appears to be growing too fast. Thus, inflation becomes a concern. When inflation becomes an issue, the Fed will likely raise rates to help cool it down. Those who aim to time the market with sectors will have the goal of catching positive returns on the upside. At the same time, they’ll want to prepare for harder declines when the market turns down. Here are a few stock sectors considered to be defensive investments:
Consumer staples (non-cyclical investments): Consumer discretionary or cyclical stocks will typically perform best during the peak times of the economic cycle and during the early stages of rising interest rates. But non-cyclical or defensive sector funds and stocks are more suitable before a recession hits, which is difficult to forecast. People still need housing, food, heating, cooling, education, and products for daily living, even during a recession. Health care: Just like consumer staples, people still need to buy their medicine and go to the doctor in both good times and bad. Health sector mutual funds and ETFs may be smart holdings when rates are rising because they may be able to weather the storm when a recession hits. Gold: When traders expect an economic slowdown, they tend to move into funds that invest in real, physical asset types. These funds may include assets such as gold funds and ETFs. Gold is not a sector, but it is an asset that has the chance to do well in uncertain times and falling markets. However, gold can be just as volatile as other investments, so don’t necessarily be swayed by past performance.
The chart below shows the gold fixing price per troy ounce from 2000 through today.
The Bottom Line
Even though you are striving to make smart purchases, you must use caution. Be aware that market timing is not a good idea for most investors. However, you can still use some of these ideas when constructing your portfolio to help you diversify.
