TFSA Investors: What to Buy to Protect Against High Interest Rates

Canadian bank stocks like Royal Bank of Canada (TSX:RY) can be good buys in times when interest rates are high.

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We are in an era of comparatively high interest rates. People who lived through the 1980s and early 1990s might laugh at that suggestion, but it’s true. In today’s market, short-term interest rates are as high as 5%. That’s higher than they were at any other time in the last decade.

It has led to even higher rates being charged on mortgages. If you’re a homeowner, you might be noticing that your mortgage payments are bigger than they used to be. That’s no accident. The Bank of Canada’s policies have explicitly raised interest rates, including mortgage rates. So, homeowners are feeling the pinch.

The question is, as an investor, what can you do about all this? Clearly, interest is a cost you need to stay ahead of. But what can you invest in to stay ahead of it? Rising interest rates tend to make stock prices fall, so it’s not obvious how you would invest to keep up. However, as you’ll see shortly, there are a few asset classes that can help investors keep up with high interest rates.

Canadian banks

Bank stocks are one type of investment that can do well in period when interest rates are high. As we saw last week, it doesn’t always work out this way, but there are some situations where it does work. For example, after rates reach a peak and the economy stabilizes. In situations like that, high interest rates can benefit banks.

One bank stock worth considering right now is Royal Bank of Canada (TSX:RY). Royal Bank is one of Canada’s oldest and most respected banks. It does retail banking in Canada, investment banking in the U.S., and wealth management in all three jurisdictions. It’s a pretty conservative bank with tight lending standards, so it doesn’t take on too many risky loans.

It made a pretty good showing in its most recent quarter. In it, the bank delivered $4.3 billion in adjusted net income, up 4%, and $3.05 in diluted earnings per share, up 7%. This wasn’t the best bank earnings of the period, but it wasn’t bad. It was certainly better than U.S. big tech companies, which delivered negative earnings growth in the same period.

The reason why Royal Bank of Canada could make good money in a high-rate environment, is because it charges higher rates on loans when interest rates are higher. The higher the Bank of Canada’s policy rate and the treasury yield, the higher the interest on Royal Bank’s loans. So, RY is one investment that can benefit from high interest rates.

Money market funds

Another investment you can consider when interest rates are high is money market funds. These funds invest in short term treasuries and pay the proceeds out to investors in the form of dividends. Typically, money market funds don’t invest in long term bonds, so they aren’t too sensitive to interest rate moves. Today, you can invest in money market funds that yield as high as 5%. These funds have higher yields in times when interest rates are high, so investing in them may be one way to keep ahead of high interest rates.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Andrew Button has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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