Investing to Manage Volatility, Inflation, & Rising Interest Rates
Investing to Manage Volatility, Inflation, & Rising Interest Rates
By: Stacey Nickens
Since the New Year, investors have been riding the stock market rollercoaster. As of mid May, all major indices have posted YTD losses. The conflict in Ukraine, rising interest rates, and inflation have all impacted market returns. With that said, how can the individual investor best manage their assets during these challenging times?
1. Mind purchasing power and interest rate risk. As investors, we often consider market risk — the risk of losing money due to general stock market volatility. The impact of this risk has been especially sharp this year, so it is no wonder that market risk is top of mind. However, long-term investors should also consider the impact of purchasing power risk. Purchasing power risk is the possibility that someone’s funds will not grow enough to outpace inflation. Assuming 3% inflation, the cost of goods and services doubles every two decades or so. Those who invest in low-growth securities or who hold a significant portion of their savings in cash can face this risk. In moments where you are tempted to pull out of the market, it can be helpful to remember that you’re not avoiding risk by doing so. You’re simply reducing certain risks while assuming others.
Similarly, interest rate risk speaks to the inverse relationship between bond valuations and interest rates. As interest rates rise, existing bonds decline in value. This decline occurs because newer bonds will be issued with higher interest rates, reducing the value of outstanding bonds. Current market volatility may have you considering moving your savings into fixed income securities. Depending on your unique situation, this move could make sense. However, before doing so, you should consider whether your bond investments will be well-positioned to withstand rising interest rates. Alternatively, you could consider increasing your bond allocation at the peak of the Fed’s interest rate increases, when new bonds will be offered with the most attractive interest rates.
2. Consider investments that are less sensitive to interest rate increases. With interest rate risk in mind, you could consider investments that are less sensitive to interest rate increases. Shorter-term bonds tends to be less sensitive to interest rate hikes than longer-term bonds. Additionally, value stocks tend to be less sensitive to interest rate hikes than growth stocks. Finally, companies with less debt will be able to better withstand higher interest rates than companies with significant debt. Considering how an investment will respond to interest rates can help you determine which hedges to add to your portfolio.
3. Diversify. Diversify. Diversify. As always, diversification is your best hedge against volatility. Diversification can look like holding more securities with smaller amounts invested in each individual security. Make sure to diversify across sectors and styles as well. Look into companies that are smaller, mid-sized, and larger. Those with a smaller amount of money to invest might look into exchange traded funds, or ETFs. ETFs hold hundreds of companies, allowing smaller investors to easily diversify with a smaller cash investment.
4. Remember your long-term goals. When planning for retirement, how much do you assume your investments will grow each year, on average? Many financial planners assume their clients’ accounts will grow between 6-8% per year, on average. This assumption accounts for both high-growth and low-growth years. In 2021, many portfolios grew by the double digits. Those same portfolios can then experience low-growth years and still have an average, annual growth rate of 6-8%. Consider reviewing your rolling three or five-year investment returns to determine if you are still on-track to meet your long-term growth goals. You may find some comfort in discovering that your portfolio is still on-track, even with this year’s dip.