Interest rate hikes have a knack for shaking up the market. With the Bank of Canada’s decision to maintain its policy interest rate at 5% after several increases, many Canadian investors are feeling the pinch.
Bank stocks have taken a dip, REITs are on a downward trend, and even typically stable bonds aren’t performing as expected.
In the midst of this, many experts and observers are questioning the possibility of a “soft landing.” With inflation still above the target and economic growth showing consistency, there’s a growing sentiment that rates might stay “higher for longer.”
But not everything is gloomy. Some ETFs are navigating these choppy waters successfully. There are funds out there delivering a solid 5% annual yield with minimal risk.
How are they achieving this in the current climate? And which ETFs are these? Let’s get into the details and see how smart investors are turning the tide.
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How interest rates affect your investments
Interest rates wield considerable influence over the investment landscape. Determined by central banks, these rates can act as a thermostat, regulating financial markets and determining the health of an economy.
When it comes to stocks, a rise in interest rates can spell increased borrowing costs for companies. This uptick in expenditure can eat into corporate profits, especially for those firms already burdened with significant debt.
On the consumer front, as loans and credit become costlier, there might be a pullback in spending, affecting the bottom line of businesses heavily dependent on consumer revenue.
Furthermore, interest rates serve as a pivotal input in many stock valuation models, thereby directly influencing stock prices.
Transitioning to bonds, they share an inverse relationship with interest rates. As rates climb, bond prices typically retreat.
The reason lies in the attractiveness of new bonds issued in a high-rate environment; they tend to offer higher yields, overshadowing the appeal of existing bonds with their now comparatively lower yields.
This dynamic can result in current bondholders witnessing a depreciation in the value of their investments, making them less useful for diversification.
On the other hand, for cash and cash-equivalent assets, a spike in interest rates can be beneficial. Such assets stand to earn more interest, while staying insulated from market volatility.
When risk-free assets like cash pay competitive yields, investors may ditch riskier assets like dividend stocks for them. This is where my ETF pick comes in.
A low-risk ETF yielding 5% and up
While equities and bonds are often the primary focus for many investors, there’s an underexplored asset class that’s gaining traction, especially in today’s uncertain market: cash.
But we’re not just talking about the dollars lying idle in your bank account. Enter special ETFs like the Purpose High Interest Savings Fund (TSX:PSA).
PSA primarily invests in high-interest savings accounts across major Canadian banks. This strategy ensures a couple of key features for investors.
Firstly, PSA maintains a steady price per share, eliminating the day-to-day volatility that’s commonplace with other assets. Secondly, it consistently pays out monthly interest to its holders, transforming cash into a dependable income source.
A standout feature of PSA is its yield’s close relationship with interest rates. As rates fluctuate, so does PSA’s yield. Currently, PSA boasts an impressive annualized net yield of 5.30%.
This figure comes after accounting for its relatively modest 0.16% expense ratio. Such yields are hard to find, especially in traditional savings accounts.
However, a word of caution is necessary. While the PSA offers an attractive return, it’s not entirely devoid of risks. Unlike a Guaranteed Investment Certificate (GIC), it isn’t backed by the Canada Deposit Insurance Corporation (CDIC), meaning deposits aren’t insured in the unlikely event of bank defaults.
Yet, considering it’s anchored by major Canadian banks, the associated risk remains minimal. In the current investment landscape, the risk-return dynamics of PSA are hard to beat.
