• / Free eNewsletters & Magazine
  • / My Account
Home>CLS: The Bright Side of Rising Rates

Related Content

  1. Videos
  2. Articles
  1. Rates May Have Further to Rise

    Bonds had a tough fourth quarter as rates rose, and there is room for both short- and long-term rates to head higher in 2017.

  2. Kinnel's Favorite Funds for Diversification

    With U.S. markets hitting new highs, Morningstar's Russ Kinnel thinks investors would be well-served to look at these diversifying investments.

  3. Low-Vol Strategies May Underperform When Rates Rise

    Interest - rate sensitivity is part of the risk with low-volatility strategies, but attractive risk-adjusted performance over the long term may make them worthwhile for some investors.

  4. Bucket Portfolios for Retirement Income: Step by Step

    Morningstar's Christine Benz walks investors through the basics of setting up and maintaining a 'bucket' retirement portfolio, including some of her favorite funds for retirees.

CLS: The Bright Side of Rising Rates


Investors have been infatuated with the timing and pace of the Federal Reserve’s (Fed’s) plan to raise interest rates ever since rates were pinned at the zero bound in the midst of the financial crisis. Most of the rhetoric regarding interest rate hikes is negative, after all, who wants to “pay more” for money? These fears for financial assets are overblown, as we have mentioned before. Besides focusing on the negatives, what are some of the benefits of higher interest rates?

Remember when your bank account paid you interest? Slowly but surely, banks are starting to raise the amount they pay customers. Online savings accounts typically have a slower process for moving funds, but those who are willing to accept a little less liquidity can get around 1% in interest. The craziness of celebrating 1% interest aside, it isn’t easy to find products paying 1% with a government guarantee (FDIC insurance) and no principal fluctuation.

Most fears regarding rising interest rates are based on client’s bond holdings (which nearly all investors have, whether they know it or not). We have written extensively on how important bonds are to portfolios and why investors definitely should not abandon them. When investing in bonds – whether through ETFs, mutual funds, or direct bond ownership –  there are interest payments and bond maturities that need to be reinvested. Reinvesting these at higher interest rates is beneficial, particularly as the starting interest rate on a bond is often the best predictor of its return.

Interest rates rarely rise in a sustainable way without a prior rise in inflation. The word inflation typically brings memories of the 1980s or stories about the Weimar Republic to mind; however, moderate inflation is typically a sign of a healthy economy. By definition, inflation implies rising prices and wages. The latest jobs report shows wages rising nearly 3% from December 2015 to December 2016, which is currently faster than CPI inflation in the U.S.

Investment vehicles that use derivatives, such as futures contracts, have to collateralize their exposure. This collateral is typically invested in short-term, safe instruments, such as T-bills. Rising interest rates benefit the collateral yield of a futures position. This is particularly beneficial to commodity investments through ETFs, which typically use futures contracts to gain that exposure. Not to mention, commodities are also a hedge against inflation, which as mentioned accompanies rising interest rates.

Interest rates are an integral part of an economic system that affect nearly everyone. Borrowing money at higher interest rates is not preferable, however, the slow expected rise in rates doesn’t have to be detrimental and can actually benefit segments of the economy and population.


The Russell 3000 Index is an unmanaged index considered representative of the U.S. stock market.  The index is composed of the 3,000 largest U.S. stocks. The S&P 500® Index is an unmanaged composite of 500-large capitalization companies.  This index is widely used by professional investors as a performance benchmark for large-cap stocks.  The Russell 2000® is an index comprised of the 2,000 smallest companies on the Russell 3000 list and offers investors access to small-cap companies. It is a widely recognized indicator of small capitalization company performance. The MSCI All-Countries World Index, excluding U.S. (ACWI ex US) is an index considered representative of stock markets of developed and emerging markets, excluding those of the US. The MSCI EAFE Index is a composite index which tracks performance of international equity securities in 21 developed countries in Europe, Australia, Asia, and the Far East. The MSCI Emerging Markets Index is a composite index which tracks performance of large and mid-cap firms across 21 countries classified as emerging market countries.  The Barclay’s Capital U.S. Aggregate Bond® Index measures the performance of the total United States investment-grade bond market. The Barclay’s Capital 1-3 Month U.S. Treasury Bill® Index includes all publicly issued zero-coupon U.S. Treasury Bills that have a remaining maturity of less than 3 months and more than 1 month, are rated investment grade, and have $250 million or more of outstanding face value. The Bloomberg Commodity Index is made up of 22 exchange-traded futures on physical commodities and represents 20 commodities that are weighted to account for economic significant and market liquidity. An index is an unmanaged group of stocks considered to be representative of different segments of the stock market in general.  You cannot invest directly in an index.

©2017 Morningstar Advisor. All right reserved.