How to invest in a high interest rate environment

Higher for longer: three little words that have had an enormous impact on the economy, the stock market, and your portfolio.

Back in January 2024, investors were confident that the Federal Reserve was on the precipice of not one, not two, but six interest rate cuts this year alone.

Instead, inflation turned out to be more stubborn than anyone thought, and it still remains well above the Federal Reserve’s target of 2%. Plus, recent economic indicators have shown that the US economy is more resilient than previously imagined, giving Jerome Powell and his motley crew no reason to cut rates anytime soon.

The result is a stock market stuck with higher-for-longer interest rates, at least for the time being. The question now becomes how to invest in a high interest rate environment like this one?

How to invest with high interest rates

For the most part, stocks have shrugged off worries about higher-for-longer interest rates. The S&P 500 is up over 12% year-to-date, as big tech (now known as the Magnificent 7) puts the market on its shoulders and carries everyone higher.

Bonds are a different story. While rates have remained high, bond prices have fallen. But the inverse is true too: when bond prices fall, bond yields rise, so there is opportunity for income-focused investors in this market at the moment. But be wary, as the bond market has basically been in a bear market ever since the Fed first hiked rates.

On the other hand, commodities have had an excellent 2024. Oil and gold have risen tremendously thanks to geopolitical concerns, copper and silver are nearing or breaking new highs as demand for tech products accelerates, and even humble cocoa and orange juice have skyrocketed.

Across these assets, investment pros recommend finding a balance that works best for your financial situation and investing goals. That said, here are a few broad strokes to help you invest intelligently.

To be clear, high inflation is bad news for stock investors — while the average returns of the stock market are about 10% per year, inflation eats into that, investor cutting profits. And high interest rates make it harder for companies to borrow money that they could put towards growth.

However, that doesn’t mean you should panic and sell your entire portfolio. Small-cap companies are deeply undervalued at the moment, since they’re more likely than their bigger peers to need to borrow money to fund operations — investing in a few now may reap rewards after the Fed cuts interest rates.

In the meantime, savvy investors may want to hedge their bets with investments in the utilities sector. It’s been a surprise winner this year thanks to the growth of AI, and also provides investors with a defensive play in case high interest rates eventually do take a toll on the economy.

Another opportunity could be in bonds, in two different ways. First, with prices low and yields high, now may be a good time to lock in high yields with long-term Treasury bonds for income investments.

Second, when the Fed eventually cuts rates, bonds will be the most immediate and obvious benefactors. It might be a smart play to buy bonds now and watch the price appreciate after cuts roll in, though the risk is that cuts will continue to be pushed back — as they already have several times this year.

As for commodities, when interest rates rise the price of commodities usually falls — but when rates are cut, commodity prices tend to move higher. That could mean good news for investors when the Fed cuts rates, but in the meantime Wall Street has gotten more bullish on commodities — for instance, Goldman Sachs recently raised its outlook on commodities to overweight in both 3-month and 12-month timeframes, citing high demand, diversification, and “continued strong performance.”