High-income earners must often consider a more complex financial landscape, which can include higher tax liabilities and sophisticated investment options. Even with a diversified portfolio and a range of investments, inflation and interest rate hikes can take their toll on the buying power of your earnings, investment options, and savings potential.
While inflation is lower in 2023 than it was, say, June of 2022 in the United States, interest rates continue to rise to combat inflation, making this a dynamic and sometimes worrisome time for investors. Fortunately, even with higher interest rates and inflation, the U.S. federal tax rates should remain the same until 2025, thanks to the Tax Cuts and Jobs Act of 2017, so for now, we need not worry about radical shifts in our tax obligations, but how, in times of high or increasing inflation, can we make the most of our investments and perhaps find opportunities?
We’ve summarized a few strategies for every type of earner to consider in order to quell their fears and find an advantage in tumultuous economic times. So, if you’re at all worried about your financial position, concerned about your investments and stock options, stymied by your purchase opportunities, or want to hedge your bets in the best, long-term interests of your family, read on, take a few notes and then bring some these ideas to your financial planner or investment advisor.
5 Conventional Investment Strategies
When making any changes to your portfolio or investment strategy, you should always consider the current state of the economy, whether it’s improving, healthy, overheated, or inflationary. A diverse portfolio across asset classes, industries, and geographies, is your first line of defense against any period of economic change or volatility.
Below are five conventional investment strategies to consider during periods of rising interest rates.
Banking Insurance and Financial Sector Investments
Banks and financial institutions historically outperform market indexes during periods of rising interest rates, as they benefit from the wider interest rate spread, making investments in financial institutions potentially advantageous during periods of high interest; insurance and brokerage firms often find similar advantages.
Bonds are an important component of a diversified portfolio. When interest rates rise, bond prices typically fall. Given the way interest rates fluctuate, long-term bonds require an investor to accept more interest rate risk. Corporate bonds tend to carry more risk than government bonds, as companies can default on their debts or declare bankruptcy.
Bond laddering — when a portfolio of bonds that mature at different dates — minimizes exposure to interest rate fluctuations. Bond ladders help to balance the need for income while managing risk through low or rising interest rate environments. Discussing tactical opportunities like employing high-yield municipal bonds, insurance-linked securities, or catastrophe bonds in the context of the current environment and your own appetites and situation is critical to success in periods of inflation.
Pro tip: Your age and proximity to retirement will inform much of your strategy for bond investing.
It’s a good time to have savings in the bank. With the Federal Reserve having raised rates to the highest levels in more than twenty years, investors can take advantage of today’s interest rates, even with the money in their savings accounts. CDs and high-yield savings accounts are good bets for cash you don’t need to access immediately. And, while the interest on high-yield savings accounts is variable, CDs have fixed rates which can prove advantageous at the higher rates. And, just like bonds, you can mitigate some risk by using a CD laddering strategy.
Companies with stable dividends can be an attractive proposition during periods of rising interest rates. Of course, high interest rates impact corporate profitability, making it harder to pay out on dividends, particularly for companies with heavy debt-loads. Dividend stocks aren’t guaranteed, and companies may dial-back or cancel dividends altogether during periods of high interest. Dividend stocks, however, can provide a dual advantage of growth in value and reliable income, so investing in well-established companies with strong balance sheets is a sensible approach, as is reinvesting those dividends to buy more shares.
Alternative Investment Approaches
During periods of high interest, there are numerous alternatives for investors, for both high and modest-income earners. While some investment opportunities are riskier than others, it always makes good sense to consult with your financial advisor and investment manager before making any investment decisions.
Periods of high interest could be the ideal time to invest in real estate. Property prices tend to be volatile when interest rates are high, providing creative opportunities for some, particularly when considering long-term investment potential. If you can afford to maintain a long-term perspective, investing in property has pretty much always been a safe investment. And investors can use the high-interest rates to their advantage when negotiating property sales, particularly if a property has been on the market for some time.
Higher interest rates translate to fewer buyers and less demand for properties, resulting in lower prices. And, with interest rates and loan affordability impacting a consumer’s ability to buy, more families will be looking to rent. So, if you find residential real estate in areas where housing is at a premium and populations are growing, you might be in a favorable position to negotiate and invest in residential real estate.
Short-term rental arrangements, like Airbnb, can provide an additional and attractive layer to residential real estate investing as you can, in some areas, rent a property in the short term for considerably more than a long-term lease agreement. However, it must be acknowledged that there are considerable legal challenges and municipal opposition to the short-term rental market in cities across the globe, so the long-term potential and risks of short-term rentals remain murky.
Commodities are raw materials, unprocessed goods that are consumed directly or are processed and resold, like gold, aluminum or cattle. Investing in commodities as a diversification strategy can provide a hedge against and provide opportunities during periods of rising interest or high inflation. Commodities are available through a variety of vehicles, including physical ownership, futures contracts, individual securities, mutual funds, EFTs, and ETNs, and hedge funds. Physical ownership of commodities like gold or other precious metals is the most basic form of commodities investing. Buying quantities of crude oil, cotton, or corn is clearly a little more involved and complex, hence options like futures contracts, individual securities, and the relatively safe mutual fund option. Employing alternative investment options like hedge funds can carry some significant risk, as well as return, so it is advisable to consult an experienced advisor in these cases.
Currency and Forex Trading
Much like commodities, currency offers the potential for appreciation, even during periods of rising interest or high inflation. As banks take advantage of the spread during periods of high interest, you can do much the same with forex trading. While potentially lucrative, forex trading is risky. As currency valuations are dictated by interest rates, changes in demand for currency are dictated or predicted by interest rates, pitting two currencies with divergent interest rates translates to opportunities for profit. However, interest rates themselves are less important than what might be on the horizon for countries and central banks.
Other Investment Opportunities
There are myriad other investment opportunities to explore during periods of high interest.
- Commodities such as fine art are one investment, as are non-fungible tokens (NFTs). However, fine art is expensive and risky to store and transport, and the potential for loss or gain through NFTs, bitcoins, and emerging decentralized and blockchain investments remains to be fully realized.
- Floating Rate Notes. Interest rate swaps and options on interest rate futures, Floating Rate Notes (FRNs) are viable options as well. These require some specialized insights or knowledge and often, as in the case of futures options and interest rate swaps, expose investors to settlement and default risk.
- Hedge funds and private equity investments appeal to individuals with high net worth. Hedge funds involve managing partners and using pooled resources to exact returns on alternative investments, while private equity firms invest directly into companies. The focus with hedge funds is maximum profit in minimal time frames, while private equity investment is focused on the long-term potential of companies held or acquired. Both hedge funds and private equity require larger investments. Hedge funds can be more risky, and private equity can take some time to see returns.
How to take full advantage of potential opportunities
With the help of an experienced professional, you can take action with an informed tax strategy to take full advantage of potential investment and savings opportunities. The strategies shared above are generalized and should always be considered in the context of your appetite for risk, life horizons, and investing goals. A skilled financial planner or wealth manager, such as the team at Northern Lights Advisors, can assist with the management of your portfolio, adjusting for inflationary conditions, identifying opportunities, and minimizing risks.
Also important is sticking to a financial plan, if you have one established, staying the course towards your investment goals, and maintaining a sound, tax-sensitive investment approach for the long term. If you have some dividends or extra income to play with, then you can enjoy a bit of investing fun and take a bit of risk — provided it doesn’t negatively impact your overall investment and estate goals.
Tax-efficient investing ensures that your returns are not unduly reduced by taxes. Since the U.S. tax code taxes various sources of income at different rates some fund types are more efficient than others. By placing investments appropriately, you can minimize your tax obligations. This is where a skilled, tax-sensitive financial planner is of tremendous advantage.
In a follow-up article, we’ll explore the tax advantages of IRAs, 401(k)s, 529 plans, HSAs, and other strategies for tax deductions, deferrals and tax-free growth.