Investors shouldn't wait until Fed raises interest rates to take action

In the scheme of things, it might not matter. It might not matter whether the Fed raises interest rates this month or in the months to come.

What matters is what you need to do now with your money in anticipation of rates rising.

The stock market roller coaster. Stock market performance has historically been dramatically better in expansive monetary policy environments — when interest rates are falling and money is cheap to borrow — vs. restrictive ones,  according to Robert Johnson, president and CEO of The American College of Financial Services and co-author of Invest with the Fed: Maximizing Portfolio Performance by Following Federal Reserve Policy.

Now, that doesn’t necessarily mean that stocks are about to collapse as they did in 1987, when the Fed started to raise interest rates. But stock investors could be in for a bumpy ride. What to do? Stand pat, says Johnson, if you have a long-term horizon, and the stomach to handle the roller coaster ride that the equity markets may take us on in the near future. “If, however, a market fall of another 5 or 10% would cause (you) to panic and sell, then I would suggest (you) sell now,” he says.

 According to Johnson, the time to gauge your risk aversion is not when the markets are rising, but when they are under pressure. “Some investors simply don't have the mindset to weather volatility in the markets,” he says.  “The silver lining in this volatility may be that it will give investors the opportunity to get a feel for their true level of risk aversion.”

BLOG:Wall Street’s ‘swing era’ isn’t all sweet notes

Shorten durations. When interest rates go up, bond prices go down. And the longer the maturity of the bond, the more prices go down.

So, in anticipation of the Fed raising rates — if only by one-quarter of 1% in September or later this year — now, if you haven’t done so already, would be the time to reduce your exposure to the long-end of the yield curve. “I believe that bond investors would be well-served to shorten the durations of their bond portfolios,” he says. Duration is a sophisticated way of looking at bond maturities. If you own bonds with long durations, you run the risk of selling at a loss.  “While the hike may not come in September — and it looks increasingly like it won't come in September — rates are going to rise and long-term bondholders are going to suffer a loss of purchasing power.” If, on the other hand, you plan to hold onto your bonds until maturity, there’s no need to sell bonds with long maturities and buy those with shorter ones.

Consider commodities. If past is prelude, consider investing in commodities — though not gold. “Now, over the next few years, I believe that an investor who buys commodities will earn returns that will exceed those in the bond market,” says Johnson.

Yes, this bet might take a bit of courage at the moment. “Commodities as an asset class are about as out of favor as an asset class can be,” says Johnson.

But your courage could be rewarded.  According to Johnson, a diversified basket of commodities represented by the Goldman Sachs Commodity Index (GSCI) returned a negative 0.19% when rates were falling and a robust 17.66% return when rates were rising. “As I expect rates to rise over the next few years, it would appear that investors should consider some allocation to commodities if the past is any indication of the future,” he says.