The 3 Best Types of Mutual Funds for Rising Interest Rates

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Now is a good time to take a look at the best types of mutual funds for rising interest rates. The Federal Reserve will likely remain in credit-tightening mode throughout 2017, and smart investors can expect at least two rate hikes during the year.

The 3 Best Types of Mutual Funds for Rising Interest Rates

There’s never a surefire bet on the timing and degree of the increases. However an environment of rising rates generally coincides with the late phase of a business cycle. When looking at the U.S. economy and capital markets through this lens, the types of mutual funds that tend to do well in this environment rise to the surface.

The late-cycle phase can be tricky because you tend to have growth stock funds outperforming but prices start to look expensive. Bond funds can also decline in value as rates climb. So you have a delicate balancing act to find mutual funds that can maximize return while minimizing risk.

With that background, here are three of the best types of mutual funds to buy when interest rates are rising, along with top fund picks for each category.

Best Types of Mutual Funds for Rising Interest Rates: Growth Stock Funds

Best Types of Mutual Funds for Rising Interest Rates: Growth Stock FundsPick 1: Fidelity Contrafund (FCNTX)
Expenses: 0.71% or $71 for every $10,000 invested
Minimum Initial Investment: $2,500

Pick 2: American Funds Growth Company of America (AGTHX)
Expenses: 0.66%, 5.75% front load
Minimum Initial Investment: $250

To play the balance of capturing growth remaining in the bull market while minimizing the worst of the downside when the next correction hits, you’re smart to think of well-managed growth stock funds like Fidelity Contrafund Fund (MUTF:FCNTX) and American Funds The Growth Fund of America (MUTF:AGTHX).

Both funds have experienced management that has navigated almost any conceivable market environment. For example, Will Danoff has been at the helm of FCNTX for more than 26 years while AGTHX employs a team management approach with the longest tenures at 20 years or more.

As for the portfolios, you’ll get a mix of super-charged growth stocks balanced with stocks that lean more toward the value side. For example, both funds include high momentum stocks like Amazon.com, Inc. (NASDAQ:AMZN) in their top holdings. But FCNTX also holds the value stock, Berkshire Hathaway Inc. (NYSE:BRK.A, NYSE:BRK.B), and AGTHX holds Home Depot Inc (NYSE:HD), which is still reasonably priced.

Best Types of Mutual Funds for Rising Interest Rates: Energy & Health Sectors

Best Types of Mutual Funds for Rising Interest Rates: Energy & Health SectorsPick 1: Vanguard Energy (VGENX)
Expenses: 0.37%
Minimum Initial Investment: $3,000

Pick 2: Vanguard Health Care (VGHCX)
Expenses: 0.36%
Minimum Initial Investment: $3,000

As the economy matures, sectors tied to raw materials and those that are defensive in nature tend to outperform other sectors. This makes mutual funds like Vanguard Energy Fund (MUTF:VGENX) and Vanguard Health Care Fund (MUTF:VGHCX) outstanding choices now.

Energy stock prices have seen a significant turnaround in 2016 and look to continue their momentum through 2017. A healthy U.S. economy and moderating oil production should hold support for higher prices for big energy companies and benefit VGENX top holdings like Exxon Mobil Corporation (NYSE:XOM) and Chevron Corporation (NYSE:CVX).

The health sector is a laggard in 2016 but the dip in prices and its defensive qualities can combine for a buying opportunity and stronger upside potential in 2017 as the economic expansion matures. Top VGHCX holdings include UnitedHealth Group Inc (NYSE:UNH), Bristol-Myers Squibb Co (NYSE:BMY) and Allergan Plc (NYSE:AGN).

Best Types of Mutual Funds for Rising Interest Rates: Short-Term Bond

Next Page Best Types of Mutual Funds for Rising Interest Rates: Short-Term BondPick 1: Vanguard Short-Term Investment Grade (VFSTX)
Expenses: 0.2%
Minimum Initial Investment: $3,000

Pick 2: Fidelity Limited-Term Bond (FJRLX)
Expenses: 0.45%
Minimum Initial Investment: $2,500

Investors needing exposure to bonds are smart to look at low-cost, short-term bond funds like Vanguard Short-Term Investment-Grade Fund (MUTF:VFSTX) and Fidelity Limited-Term Bond Fund (MUTF:FJRLX).

With more rate hikes to come in 2017, bond prices will remain under pressure and investors are wise to steer clear of mutual funds that hold bonds that are the most interest-rate sensitive.

In general, when interest rates are rising, the longer the maturity, the steeper the decline in price. Therefore a smart bet for bond funds in 2017 is short-term bond funds.

Our top picks for short-term bond funds, VFSTX and FJRLX, both have diversified portfolios of bonds that average short maturities. They also beat their primary benchmark, the Barclays U.S. Aggregate Bond Index, in 2016, and could stay ahead in 2017 when more interest rate hikes are almost certain.

As of this writing, Kent Thune did not personally hold a position in any of the aforementioned securities, although he holds FCNTX for some client accounts. His No. 1 holding is his privately held investment advisory firm in Hilton Head Island, SC. Under no circumstances does this information represent a recommendation to buy or sell securities.


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