When interest rates rise, the market has a struggle. The problem is that though bonds become attractive to new investors (since they begin to pay higher interest rates), the investors that have already bought the previous, lower interest-rate bonds are stuck in their previous arrangement. To get out of that arrangement becomes expensive and those investors risk losing ground on the returns they have collected so far. That means bond funds become less attractive. Now people investing with their 401k or IRA accounts aren’t able to invest directly in bonds. They have to use bond funds. That means that in times of rising interest rates, moving money into bonds is a bad idea, because the prices of those bond funds will go down.
So what to do? Should you simply invest in stocks instead? That’s difficult to tell because stocks sometimes go up and sometimes go down when interest rates rise. Generally speaking, you won’t expect to see stocks make significant gains over a longer period of time if interest rates are rising, so stocks aren’t the best idea at that time either. The best idea is likely to be cash, or in the case of 401K or accounts it will be the money market funds. If you have a high risk tolerance, then you might consider putting half your savings in the money market fund and then allowing yourself to put money the other half in a mix of stocks and bonds.
In an IRA you’ve got a lot more options. You can purchase TIP, an inflation protected bond fund, or you can purchase TBT, an inverse fund that moves up when bond funds go down! You can also look around the globe to see what countries have a booming economy. All you need to do is bring up a chart of these country-specific ETFs and compare it to SPY similar to the way the book talks about comparing the utilities index with the S&P 500. Here are some country-specific ETFs to consider under those circumstances:
EWG – Germany
EWS – Singapore
EWZ – Brazil
EWP – Spain
EWC – Canada
EWH – Hong Kong
EWA – Australia.
If any of these stocks is going higher faster than the SPY, it will make a suitable replacement for the portion of your money you want to put into stocks.