While rising interest rates generally indicate a strong economy, not all investments will be a winner. Here's why a few types of investments could decline as the Fed raises interest rates.
A full transcript follows the video.
This video was recorded on March 26, 2018.
Michael Douglass: Thinking, then, about folks who might benefit less or even lose a little bit in a higher interest rate environment, there are a number of sectors and areas we can talk about here.
Matt Frankel: Yeah. Real estate is definitely a big one. I'll call myself one of the losers here, because I own a lot of real estate investment trusts. Generally anything that is an income-based investment -- think high-dividend stocks like REITs, think bonds -- tend to do poorly when interest rates rise. The yields go up, which is why the prices go down, as interest rates rise. If you're buying bonds now or in the future, you can expect a higher yield on them. If you're holding bonds that you already bought in the past, the value of those bonds will go down in order to make the yields rise. The same holds true for dividend-focused stocks like REITs like I mentioned. I can personally tell you that as rates have started to rise over the past couple of years that the REITs in my portfolio have been the worst performers. So, I wouldn't expect anything different over the next few years, although I still love them as long-term investments. They're not going anywhere.
Douglass: Right. The REIT part of my portfolio has not been the worst-performing part of my portfolio, but that's because I've bought some real duds over the years [laughs] that have not been REITs, but have been other companies that have really struggled. Every investor has their stories of stocks that have, let's just say not gone quite as they predicted, and I certainly have my fair share of them.
But, this is an important point for us to note and to really consider, which is that as bond yields go up, we can probably expect some income investors, perhaps some of our listeners, even, to think about, "I could be in this dividend aristocrat, this very comparatively safe dividend stock, which is paying a 2-3% yield. Or, I can be in this bond that's paying 4-6%, depending on how things go with interest rates." And that could really make for this interesting trade off, where you might really rather get the income. One of the reasons so many retirees and income-focused investors have been in dividend stocks have been because bond yields have been so low for so long. As that shifts, it really could have some big implications for, broadly speaking, the dividend sector.
Frankel: Definitely. I'll be honest, if I saw a pretty safe bond that was yielding 6-7%, I'd have to think twice about taking risks on a certain stock I was looking at. So, you could definitely see this put pressure on income investments, stocks and bonds, over the next few years.
Douglass: Right. Of course, that assumes that the Fed continues raising rates, and that bond yields continue to improve, etc. As I mentioned earlier, predicting the future is not something people are really terribly good at. We're not planning to predict the future here, but this is certainly a possible outcome.