How to Act When Interest Rates Move

NOTHING affects the prices of your investments more than changes in interest rates. Here are answers to some common questions about consequences of those changes and how to act on them.

Can you make profits on bonds when interest rates fall?

Yes, you can. Since bond prices rise when interest rates decline and vice versa, a skillful trader can make money by buying bonds at the top of the interest rate cycle and then selling at the bottom. The trouble is those once steady interest rates have been bouncing down and up quite quickly and this new volatility makes bond trading riskier than ever.

When interest rates fall, does it make sense to buy stocks?

Yes, it often does. Lower interest rates reduce a company's costs and thus lift its profits and often its stock price.

What stocks do best when rates fall?

Many stocks do well at those times. Among them are the shares of banks and savings and loan associations, because they can pay lower interest rates to depositors. Utilities are big borrowers, and so they stand to gain when their interest costs decline. Lower rates also help boost the housing market, so real estate investment trusts, lumber companies and appliance manufacturers also prosper.

Do any stocks perform well despite high interest rates?

High rates reflect expectations of steep inflation, and investors turn to natural resources as inflation hedges. So oil, gas and mining company stocks tend to rise.

Should you buy stock on margin when rates are high?

Not unless it's a very promising stock. The interest you pay is tax deductible up to the amount of net income you earn from your investments. But when rates are high, your stock still would have to rise quite a bit for you to break even after taxes.

If you want to play absolutely safe, where can you invest your money when rates are high? Four financial instruments offer a safe return at close to top interest rates: money market funds; bank money market deposit accounts; six month money market certificates; and U.S. Treasury bills with maturities of 90 days to a year.

But do these four have any disadvantages?

Yes, they do. Since these investments are short term, you can't lock in high rates for very long. Also, remember that the minimum investment for Treasury bills is $10,000.

Should you borrow on your life insurance to invest when rates are high?

Yes, if you have a whole life policy that you bought before 1980. You often can borrow against the cash value of such a policy at a rate between 5% and 6%, put the cash in a money market fund and earn considerable profit with little risk. But since you decrease the value of the policy by the amount you borrow, you should be sure to make your beneficiary the heir to the investment.

Should you buy gold or silver when rates are steep?

No. When Treasury bills and other safe alternatives offer high yields, precious metals lose their luster for many investors, and prices can drop sharply.