Interest rates are on the rise and may rise further.
Canada’s most recent inflation report showed that the consumer price index rose 3.8% year over year last month. A U.S. inflation report showed a similar rate of inflation.
What does that have to do with interest rates?
It’s pretty simple: the reason central banks are raising interest rates is to fight inflation. The target inflation rate is 2%. Whenever there is more inflation than central banks desire, the bankers usually respond by raising interest rates.
In this article, I will explore three categories of assets you can buy to take advantage of rising interest rates. These are all assets that I’ve been buying myself this year, so I’m putting my money where my mouth is with this one.
Guaranteed investment certificates (GICs)
GICs are bond-like investments that you buy from banks. The way they work is, you invest a certain amount of money up front, and the bank pays you more at maturity. Today, you can find GICs with yields up to 5.5%. That’s enough of a return that if you invest $10,000 in one, you’ll get $550 at maturity. Canada’s inflation rate is 3.8% now, so that’s a positive real return!
Bank stocks
Bank stocks are another type of asset I’ve been buying this year. They are simply the shares in the banks that you use to deposit money in and borrow money from.
Consider Toronto-Dominion Bank (TSX:TD), for example. It’s a Canadian bank stock with a 4.8% dividend yield. With a 4.8% yield, you can get $4,800 in annual cash back on every $100,000 invested. If the dividend grows over time, you may get even more than that!
Why are bank stocks good assets to hold when interest rates rise?
It’s because they lend money! Rising interest rates are bad for almost every type of business, except those that lend out money. If you issue loans, you get to collect rising income as rates rise. That’s exactly the situation that TD Bank is in. It does have an inverted yield curve to worry about, but that hasn’t hurt its profitability so far this year.
Non-bank lenders
Last but not least, we have non-bank lenders. These are like banks, only they don’t take deposits, so they don’t need to worry about liquidity as much. This year, I invested in the 11% yielding Oaktree Specialty Lending, a business development company that makes money lending money to distressed companies. That’s a U.S. stock, but there are similar Canadian ones.
Consider First National Financial (TSX:FN), for example. It’s a Canadian mortgage lender that makes money loaning out money to homebuyers. It operates much like the Big Six banks in this regard, only it doesn’t take deposits. It issues bonds to finance its own loans, and it matches the term to maturity of its bonds to those of its own loans. So, it doesn’t need to worry about a sudden drop in liquidity caused by depositors fleeing. It’s a winning formula, and the proof is in the pudding: FN’s most recent quarter was a large beat, with major increases in revenue and earnings.
