The Federal Reserve has done everything in its power to prepare investors for an interest rate hike. However, the change in interest rates is still likely to catch some by surprise. We believe there is a high probability that the Fed will begin raising rates this fall, although we think the rate of increase will be very slow with periodic pauses due to macroeconomic conditions. Before the Fed makes its move, here are a few things to consider:

Create a Charitable Lead Trust
For those who are charitably inclined, the current low interest rate environment favors charitable lead trusts. A charitable lead trust is designed to shift wealth to beneficiaries in a tax-efficient manner. Under the terms of the charitable lead trust, a percentage of the trust is paid out to charity annually. At the end of the charitable lead trust’s term, the remaining assets are distributed to the grantor’s children or other noncharitable beneficiaries. Charitable lead trusts work well in a low interest rate environment because if the trust’s investment performance exceeds an interest rate determined by the IRS (currently it is approximately 2%), then the excess earnings and growth at the end of the term pass to the remainder beneficiaries tax-free. The lower the interest rate, the larger the potential gift to family.

Adjust Your Bond Portfolio
Bond investors have benefited from a steady decline in interest rates over the last 35 years. As interest rates begin to rise from historic lows, investors need to be prepared for low to negative returns. Being defensive can help. Bonds with shorter maturities are less affected by interest rate changes than longer bonds because bond holders will get their money back sooner to reinvest at the new interest rate. Liquidity is an important component and an often-overlooked element when investing in bonds or bond funds. We recommend holding some cash or cash equivalents such as short-term US Treasury Notes as a way to protect portfolios if bond prices decline and liquidity dries up.

Refinance Your Mortgage
Higher interest rates will push up borrowing costs for home and auto loans. The majority of homeowners have already taken advantage of today’s record low rates and refinanced their 30-year mortgages. Jumbo loan rates for a 30-year fixed mortgage are currently at 4.25%. But for those who opted for an adjustable rate mortgage, if rates rise, monthly payments could increase significantly. Now is the time to lock in a long fixed rate and erase any uncertainty over future interest rate increases.

Increase Exposure to Small Company Stocks
Think about increasing exposure to smaller US-based companies. Smaller companies do not face the same currency headwinds that negatively impact large US multinational companies. Rising interest rates and a strengthening of the dollar are highly correlated. If the Fed initiates rate hikes as European and Asian central banks hold their rates steady, the dollar will continue to strengthen. As a result, smaller companies’ earnings will be stronger than those of their larger competitors. At some point, interest rates will rise. This will hurt fixed income investment portfolios and borrowers will be forced to pay more for home and auto loans. That said, rising rates are a sign that the economy is improving and will be a welcome sight for those net savers looking to generate higher income.

Individual investment positions detailed in this post should not be construed as a recommendation to purchase or sell the security. Past performance is not necessarily a guide to future performance. There are risks involved in investing, including possible loss of principal. This information is provided for informational purposes only and does not constitute a recommendation for any investment strategy, security or product described herein. Employees and/or owners of Nelson Roberts Investment Advisors, LLC may have a position securities mentioned in this post. Please contact us for a complete list of portfolio holdings. For additional information please contact us at 650-322-4000.