With the Bank of Canada’s recent decision to hold the policy interest rate at 5%, it’s clear that we’re in for a change in the economic climate.
For the everyday Canadian, especially those with loans or mortgages, the immediate effect feels like a pinch — borrowing money just got more expensive.
But it’s crucial to step back and see the forest for the trees. The decision to maintain a higher interest rate is, in many ways, a tough medicine intended to stave off the fever of high inflation over the long run.
While no one enjoys short-term financial discomfort, the alternative — battling a decade of runaway inflation — would be far worse for everyone’s wallet.
Before diving into how you might tweak your investment strategy in response to rising rates, it’s worth considering a simple, yet powerful action: doing nothing.
That’s right; sometimes, the best move is to stay the course. A well-diversified portfolio is designed to weather all sorts of economic storms, and over the long term (think several decades), the impact of rising interest rates tends to level out.
But what if you’re keen on not just weathering the storm but capitalizing on it? I’ve got an exchange-traded fund (ETF) in mind that could be a smart addition to your portfolio, tailored for these times of rising interest rates.
Image source: Getty Images
Why cash is the real winner when rates rise
When interest rates go up, it’s a signal that the cost of borrowing money is getting steeper. This can make both stocks and bonds less attractive to investors but for different reasons.
Companies often rely on borrowing to fund growth, innovate, and manage day-to-day operations. When it costs more to borrow, it can eat into their profits because they’re paying more in interest. This can be particularly tough on companies with high levels of debt.
Also, for potential investors, the higher interest rates mean they could get a better return elsewhere (like from a savings account) without taking on the risks that come with stocks. If investors start thinking this way, demand for stocks can decrease, which can lead to falling stock prices.
When interest rates rise, the fixed payments from existing bonds also don’t look as appealing because new bonds are being issued at higher rates, which promise better returns.
The longer the duration of the bond (which means the longer you have to wait for the bond to pay back its face value), the more sensitive it is to changes in interest rates.
So, if you have a bond that won’t mature for another 20 years, a rise in interest rates could significantly decrease its market value, as new bonds will offer higher yields.
It’s this environment where holding cash can become particularly valuable, as it’s not subject to the same market dynamics and can actually earn more as rates increase.
This ETF is better than cash
When we talk about cash as an investment, we’re not suggesting stashing physical bills somewhere safe in your home. In the investment world, “cash” often refers to holding money in highly liquid and low-risk vehicles like savings accounts or money market funds.
In a brokerage account, you can hold cash equivalents that are easily accessible and secure. One such option is the Horizons High Interest Savings ETF (TSX:CASH).
CASH operates like a savings account in the form of an ETF. It puts your money into high-interest-bearing deposit accounts held with Canadian banks. It’s a way to earn interest on your cash holdings while waiting for other investment opportunities.
As of now, CASH touts a 5.40% gross yield. That’s a competitive rate, especially when compared to traditional savings accounts and even some longer-term investment options.
As an added advantage, CASH pays out interest monthly, which is a nice feature if you’re looking for regular income from your investments.
Essentially, with CASH, you’re getting a steady, interest-bearing investment that can serve as a secure place to park your money and still earn a relatively high yield, which can be a smarter play than traditional cash, especially in a rising-rate environment.
