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The Best Way to Protect Against Rising Interest Rates

As I write this, the S&P 500 has surged another 18% over the past 12 months. It’s a stock market rally that seems as if it will never end. But of course, it will. And maybe sooner rather than later.

I am encouraging many of my clients (especially those that are closer to retirement) to give much greater consideration to bonds than they have in the past. Bonds don’t generate the kinds of strong returns that stocks can, but they provide an important source of portfolio diversification. 

Trouble is, bond investing can be a bit tricky these days. Remember that bonds (and bond funds) can lose value when interest rates rise. That’s because they become comparatively less appealing once new (and higher-yielding) bonds are issued and priced for sale.

There is a pretty simple solution to the challenge: bonds funds that protect against—and can actually profit from—rising interest rates. I first discussed this issue in an article published by ETF Advisor magazine, a subsidiary of Financial Advisor magazine.

Here’s a quick review of some funds that are well-suited to the current era of rising interest rates.

The Sit Rising Rate ETF (RISE) uses a series of financial investments (futures and options contracts) that rise in value as interest rates rise. The fund has increased its value by nearly 10% over the past 12 months, far better than plain vanilla bond funds.

The Fidelity Dividend ETF for Rising Rates (FDRR) is another fund to consider. This fund the fund is aimed at high-growth sectors that tend to do well when the economy is strengthening. The fund is up nearly 15% over the past year and is also likely to fare better than typical stock investments when the market heads south, thanks to its reliance on high-dividend firms that are typically more stable. 

Lastly, you may want to check out the iShares Interest Rate Hedged Corporate Bond ETF (LQDH). The fund deploys interest rate swaps that increase in value as rates rise. The fund has returned around 4% in the past 12 months, and also offers a 3.26% yield.

When you consider that the federal reserve aims to hike interest rates on five more occasions between now and early 2020, these funds should continue to outperform other bond funds.