How Will Rising Interest Rates Affect Your Dividend Stocks?
Equity REITs (those that own properties) also borrow money and could be hurt by rising borrowing costs. However, many equity REITs maintain relatively low debt levels, but could also face selling pressure as income-seekers flee to "safer" fixed-income assets.
Utilities -- Not only do utilities tend to carry a lot of debt, which can lead to contracting profit margins if rates rise, but utilities generally don't produce much growth and pay out most of their earnings as dividends. In other words, these relatively high dividends are more like bonds in the eyes of income investors, and if bond yields rise to a comparable level, utility stocks seem much less attractive.
And others could thrive when rates rise
As I briefly mentioned earlier, some industries actually benefit from rising interest rates. To name just a few:
- Banks -- Banks that make most of their profits from lending money are in a good position to profit from rising rates. Lenders make their profits from the spread between how much they pay to borrow money and how much interest they can collect when they lend the money to customers. As rates rise, this spread tends to widen. In fact, in its most recent earnings presentation, Bank of America projected that its net interest income could grow by as much as $3.9 billion over the next 12 months as interest rates normalize.
- Insurance companies -- Contrary to the belief of many investors, insurance companies generally don't make much of a profit from the premiums you pay. Instead, they take that premium income and invest it -- profiting from the income generated from these investments while waiting to pay claims. Since insurance companies are highly dependent on their ability to generate interest income (most insurance company investments are fixed-income), rising rates can significantly boost profits.
- Tech stocks -- Generally speaking, tech companies don't carry much debt, and many that do have debt issued it because rates have been low lately. This is especially true of the larger, established dividend-paying tech companies. For example, Apple has more than $47 billion in long-term debt on its balance sheet, but it issued its debt in order to take advantage of record-low interest rates, not because its business depends on borrowed money. Additionally, tech companies stand to benefit from higher sales as the economy improves. As consumers have more disposable income and are more confident in their financial condition, Apple will sell more iPhones, Intel will ship more processors, and Microsoft will sell more software.
The moral of the story: Diversify and think long-term
Just like virtually any other factor that could potentially affect the stock market, rising interest rates are good for certain dividend stocks and bad for others.
Bear in mind that nobody knows exactly when rates will start to rise, how many increases there will be, and how long the higher rates will last. For that reason, it's unwise to try to time the market by buying nothing but stocks that will benefit from rising rates. In contrast, the best thing you can do is to develop a diverse portfolio of companies that will be winners over the long term. If you do this, some of your portfolio will benefit when rates rise, and others when rates fall once again. With this approach, over time you're almost certain to be a winner.
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The article How Will Rising Interest Rates Affect Your Dividend Stocks? originally appeared on Fool.com.
Matthew Frankel owns shares of Bank of America. The Motley Fool owns shares of and recommends Apple. The Motley Fool owns shares of Microsoft. The Motley Fool recommends Bank of America and Intel. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .
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