How to invest when the cost of money is on the rise

PERSONAL FINANCE

June 04, 2000|By EILEEN AMBROSE

As Federal Reserve policy-makers prepare to meet this month, questions hang in the air: Will they or won't they? And if so, by how much?

Most financial experts agree that the Fed, which has bumped up rates six times in the past year, has more tightening to do to head off inflation and will raise rates one or two more times before the presidential election. Many predict that rates will go up at least a half-percentage point more.

For investors, there's another question: How do you invest in times of rising rates? It's not easy, experts agree.

"Investors are anxious and at times confused by conflicting signals they get when rates are rising," said Alan Skrainka, chief market strategist for Edward Jones in St. Louis. On the one hand, they hear that technology companies are immune to rate increases because they don't carry debt; on the other hand, investors are advised to rush into gold, the traditional hedge against inflation, he said.

But the Nasdaq composite index, heavily weighted with technology stocks, is down more than 6 percent since the beginning of the year. Gold, too, is down for the year.

As always, factors such as age, goals and risk tolerance determine the best investment strategy for individuals. But experts say investors these days can benefit from asset allocation, or spreading money among stocks, bonds and cash, as well as diversifying investments within various asset classes.

"You should not have all your eggs in one basket if you are a long-term investor," said Richard Cripps, chief investment strategist for Legg Mason Wood Walker Inc. in Baltimore. "Today's losers can be tomorrow's winners."

Investors also are advised not to make dramatic portfolio shifts.

"That's usually a bad idea because the outlook can change quickly," Skrainka said. "Making a large shift in your portfolio is the equivalent to market timing, which really never works."

But if investors want to fine-tune holdings, experts say, these investments may help weather a climate of rising interest rates:

Consider stocks that pay good dividends, said Chuck Carlson, editor of the DRIP Investor Newsletter in Hammond, Ind. "Higher yields give you some return during a market environment where capital gains may be tough to come by," said Carlson.

Utilities, though sensitive to interest rate boosts because of heavy borrowing for maintenance, traditionally have paid high dividends. Investors already have been seeking safe haven in reliable utility stocks that aren't affected by economic cycles, experts said. So far, the Dow Jones utility average is up 14 percent this year.

Like utilities, real estate investment trusts, which manage portfolios of real estate, are affected by rate increases but are providing attractive yields now, experts said. REITs pay out their income for the year to shareholders as dividends, which are running at yields of 7 percent to 9 percent, said James Stack, president of InvesTech Research in Whitefish, Mont.

"Earning 7 or 9 percent may seem boring, but it beats losing 35 percent in the Nasdaq," said Stack, referring to the drop in the Nasdaq from its high in early March.

Investors should look for companies that won't be hurt if the Fed succeeds in putting the brakes on the economy, experts advised.

People don't cut back on consumer staples, such as food, or prescription drugs when the economy slows, which makes shares in those types of companies attractive right now, said David Straus, senior portfolio manager with J. L. Capital Management Inc. in Washington.

The consumer staples and drug sectors have been beaten down in the past year or so as investors have flocked to high-flying technology stocks, Straus said. In addition, consumer staples have been hurt by slower revenue growth, and pharmaceutical stocks have lagged because of concern about Medicare reform and possible price controls on prescriptions drugs, he said. Investors have already been moving money into these sectors because of their lower stock prices, Straus said.

Go bargain-hunting for quality value stocks or shares in companies that have had a temporary setback and are out of favor with Wall Street, experts said.

"They typically perform better than growth stocks in a rising interest rate environment," said Legg Mason's Cripps.

Value stocks often are viewed as less risky when rates rise. It doesn't mean they won't fall if the market continues to weaken, but "they will go down far less than the high-fliers," Stack said.

Stocks aren't investors' only choice, of course.

"For a conservative well-balanced portfolio, now is a great time to look at tax-free municipal bonds," said Jonathan Murray, a Legg Mason financial adviser.

A Maryland municipal bond of intermediate maturity yields about 5.25 percent. But considering that investors don't pay state or federal taxes on the earnings, it's the equivalent of earning about 8.7 percent, he said.

Then there's good hard cash.

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