How To Take Advantage Of High Interest Rates

How To Take Advantage Of High Interest Rates
Theodora Lee Joseph, CFA

9 months ago9 mins

  • With interest rates set to creep higher and a recession potentially looming, it makes sense to prioritize maximizing your investment yield potential over price growth over the next year or two.

  • The average annual return from the S&P 500 over the past two decades (2002-22) was 8.14%, but with interest rates where they are, you can already lock in more than half that return through relatively risk-free deposits.

  • Traditional dividend stocks no longer look as appealing to investors, compared to these other options.

With interest rates set to creep higher and a recession potentially looming, it makes sense to prioritize maximizing your investment yield potential over price growth over the next year or two.

The average annual return from the S&P 500 over the past two decades (2002-22) was 8.14%, but with interest rates where they are, you can already lock in more than half that return through relatively risk-free deposits.

Traditional dividend stocks no longer look as appealing to investors, compared to these other options.

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With interest rates expected to creep higher still in most of the US and Europe, you’re going to want to know where to get the highest yield on your investments. And since we can’t rule out the possibility of another recession, it makes sense to prioritize maximizing your investment yield potential over price growth over the next year or two. So, I’ve put together a list of ten of the best investment options. Whether you’ve got small or big pockets, are a nervous investor or a risk junkie, you’ll find something here that suits you.

1. High-interest savings account

You’re probably familiar with the typical savings account offered at your local bank. Well, these accounts pay slightly higher interest rates. The catch is that you typically need a relatively high minimum deposit to qualify, have to give a notice period (usually one to three months) before withdrawal, and are limited in terms of how many withdrawals or transfers you can make. It’s not a bad short-term option, though, if you’re worried about markets.

Average yields: As of early June, you could earn yields of up to 5.05% in the US, and up to 4.45% in the UK.

Risk-o-meter: 1/10

What to be aware of: These yields vary considerably, so you’ll need to sniff around for a good rate. Bank deposits are usually insured up to a certain amount, depending on your jurisdiction.

2. Fixed deposits

These deposits work very much like your savings deposits, but they have less flexibility and require a minimum fixed term to lock in. In turn, your interest rate is guaranteed for the fixed term. Generally, the longer your fixed term, the higher the interest rate.

Average yields: 5.5% in the US and UK for a 12-to-24-month fixed rate.

Risk-o-meter: 2/10

What to be aware of: Your rates are dependent on central bank policy moves. If you think central banks are going to cut rates, you might consider a longer-term fixed deposit to lock in today’s higher interest rates.

3. Money-market funds

These are a type of investment fund that invests in low-risk, highly liquid, short-term debt from governments, banks, and companies with strong balance sheets and high credit ratings. These funds are typically managed by financial institutions like mutual fund companies or investment banks.

Average yields: 4.88% in the US.

Risk-o-meter: 3/10

What to be aware of: They are very similar to bank deposits, but unlike deposits, MMFs aren’t insured by the Federal Deposit Insurance Corporation (FDIC) in the US, so this is not a guaranteed investment. The value of your MMF can rise or fall, so you could lose more than you invested, although the historical risk of that is low.

4. Covered call ETFs

Covered call ETFs make use of option strategies to generate higher yields. Rather than buying index ETFs, you can buy covered call ETFs on the index itself. These funds sell call options (the right to buy) on a proportion of their underlying stock position, generating extra income from the price (or “premium”) of the options they sell. They generate extra income from the price of the options they sell. If the option is exercised by the buyer, the fund has to sell the stock that they already own in their portfolio, at the agreed-upon price (or “strike price”).

Average yields: 10.5% to 11.5%.

Risk-o-meter: 4/10

Examples: The Global X S&P 500 Covered Call ETF (ticker: XYLD; expense ratio: 0.6%), the Global X Russell 2000 Covered Call ETF (RYLD; 0.6%), or the JPMorgan Equity Premium Income ETF (JEPI; 0.35%).

What to be aware of: These funds can provide higher yields, lower your portfolio volatility, and give you strategic flexibility, but they come with a cap on your potential profit. They also work best in a “sideways-moving” market with high volatility. There are many types of covered call ETFs you can invest in because calls can be bought and sold on almost any index, sector, or stock.

5. Real Estate Investment Trusts (REITs)

REITs are structured like mutual funds, but the biggest difference is that the majority of their assets must be invested in real estate. The REIT owns, operates, or finances income-producing real estate ranging from residential and commercial properties, to data centers and cell towers. Many REITs are publicly traded on major securities exchanges, and you can buy and sell them like stocks.

Average yields: Average yields are between 4% and 5%, but yields can be as high as 14% on certain REITs.

Risk-o-meter: 4.5/10

Examples: The VanEck Mortgage REIT Income ETF (MORT; 0.41%), the iShares Mortgage Real Estate ETF (REM; 0.48%), and the iShares European Property Yield UCITS ETF (IPRP; 0.4%).

What to be aware of: Unlike purchasing actual real estate, with REITS, you get little in the way of capital appreciation. That’s because they’re mandated to pay 90% of their income back to investors and reinvest only 10% back into new holdings.

6. Traditional dividend stocks or ETFs

Stocks that tend to generate strong cash flows often return cash to shareholders regularly through dividends. You’ll often find stable high-dividend-yielding stocks in mature, slow-growing, low-volatility industries like utilities, telecommunications, energy, and consumer staples.

Average yields: The energy and real estate sectors in the US are two of the highest-yielding ones in the US and have a trailing 12-month dividend yield of 3.96% and 3.42%, respectively.

Risk-o-meter: 5/10

Examples: The Franklin International Low Volatility High Dividend Index ETF (LVHI; 0.4%), the WisdomTree International Hedged Quality Dividend Growth Fund (IHDG; 0.58%), the iShares Euro Dividend UCITS ETF (IDVY; 0.4%), and the Xtrackers EURO STOXX Quality Dividend UCITS ETF (XD3E; 0.3%).

What to be aware of: Companies can cut their dividends, so rather than buying individual high-dividend stocks, you can buy dividend ETFs instead. Unlike high-yield deposits or MMFs, you get to participate in the potential share price appreciation (or depreciation) of the stocks.

7. Midstream master limited partnerships (MLPs)

These tax-advantaged partnerships can afford to be generous with their dividends because of their tax structure, which reduces their cash tax liabilities in the US. Midstream companies own the energy infrastructure that connects the production “wellheads” upstream to their clients downstream, and charge a fee for anyone who uses it. Essentially, they don’t produce any oil or gas, but they’re involved in the logistics of it all: gathering, processing, transporting, and storing.

Average yields: 7% to 8%.

Risk-o-meter: 6/10

Examples: Individual stocks include Magellan Midstream Partners and Hess Midstream LP, and ETFs include the Invesco Morningstar US Energy Infrastructure MLP UCITS ETF (MLPD; 0.5%), the Alerian MLP ETF (AMLP; 0.85%), and the L&G US Energy Infrastructure MLP UCITS ETF (MLPX; 0.25%).

What to be aware of: When you invest in MLPs, whether through single stocks or ETFs, you’re gaining indirect exposure to the energy sector. The drivers of growth and risks are similar to those in the energy sector, but without the volatility that comes from being tied to oil and gas prices.

8. High-yield bond ETFs

Think of bonds as loans given to governments or companies, which they pay back with interest, delivering a regular income stream for investors. How much income a bond provides is mainly dependent on the credit rating of the bond issuer, and how long the loan is set for. High-yield bonds, sometimes called “junk” bonds, tend to be issued by corporations with bad credit ratings.

Average yields: 11.5% on certain high-yield bond ETFs, with an average of 5% to 6% for high-yield bonds.

Risk-o-meter: 8/10 (but there’s a wide range depending on the bond ETF you pick)

Examples: The BlackRock Floating Rate Loan ETF (BRLN; 0.55%), the iShares € High Yield Corp Bond UCITS ETF (IHYG; 0.5%), and the iShares $ High Yield Corp Bond ESG UCITS ETF (DHYG; 0.27%).

What to be aware of: High-yield bond ETFs are sensitive to changes in interest rates. When interest rates rise, bond prices typically fall, which can result in a decline in the value of the ETF. Furthermore, high interest rates can threaten the solvency of many companies with poor credit ratings.

9. Rental properties

If you’ve got a healthy chunk of money to invest, another great way to enjoy passive income is to buy a real-estate property and rent it out. Property is generally seen as an inflation-busting asset with long-term price appreciation potential.

Average yields: The pace of appreciation varies widely within a country. As they say in real estate, it’s all about location, location, location. Average rental yields are 5% to 6% in the US and UK.

Risk-o-meter: 3/10

What to be aware of: Compared to other investment options, you’ll likely need to spend a lot more time and effort researching the best areas to buy. You’ll also face additional costs in securing a mortgage, engaging legal experts, and managing the property. Depending on where you’re based, tax rules on property investors might be tightening, and that can negatively impact your net returns. Also, since yields vary so widely across cities, even within a single country, you’ll really need to do your homework before you invest.

10. Property crowdfunding

This is a way to gain access to real-estate investing even if you haven’t saved up enough for a downpayment or a deposit on a property. Multiple platforms exist that allow you to invest – including crowdfunding a property or even investing in loans to real-estate developers. You can choose which part of the value chain you’ll like to be involved in.

Average yields: They’re highly variable. But generally, you could earn anywhere from 4% up to 16%.

Risk-o-meter: 9/10

Examples: Companies that offer this kind of investment include Fundrise, Yieldstreet, Estate Guru, Rendity, Shojin Property Partners, CapitalRise.

What to be aware of: Liquidity is low because there’s usually a minimum lock-in period for your investment that can range from one to four years. These investments have attractive yields, but they also come with higher transaction costs. And because they’re classified as high-risk investments, you may need to earn above a certain amount or have a minimum amount of assets to invest (i.e. you may need to be an “accredited investor”).

So what next?

Interest rates move, so the yields from these ten investment options are probably going to change. For context: the average annual return from the S&P 500 over the past two decades (2002-22) was 8.14% but with interest rates where they are, you can already lock in more than half that return through relatively risk-free deposits. Better still, many of these options have a low correlation to the market – meaning, they won’t necessarily fall if stocks fall – and that can help diversify your portfolio, better insulating you against a possible recession.

Ultimately, the options you choose will depend on your risk tolerance, your investment horizon, your view on future interest rates, and your overall preference for yield or price appreciation. Don’t forget that taxes can have a big impact on your final return. For example, REIT dividends are taxed as regular income in the US, so make sure you make use of tax-advantaged accounts where possible.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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