Best ETFs for rising interest rates

The Federal Reserve has furiously raised interest rates throughout 2022 and 2023 as it tries to rein in high inflation. After going through much of 2020 and 2021 in a zero-rate environment, investors got comfy with a very accommodative Fed, which floored the gas pedal to help the economy through the pandemic. But now with a stronger economy and high inflation, the nation’s central bank is hitting the brakes, making things harder for stock investors and others.

So how do investors continue to invest in this climate and how can they use ETFs to do it? Here are some of the best ETFs for investors looking to defend themselves, and even thrive, amid rising rates.

Which types of ETFs tend to perform well when rates rise?

With rates rising, investors are looking for the best industries and investments that can thrive in that environment. The types of investments that tend to do well as rates rise include:

• Banks and other financial institutions. As rates rise, banks can charge higher rates for their loans, while moving up the price they pay for deposits at a slower pace. (That’s one reason to focus on finding a high-yield online savings account.) However, some banks may find themselves sitting on large unrealized losses if they invested in long-term bonds when rates were low.
• Value stocks. Stocks trading at a relative discount tend to do better as rates rise and investors turn away a bit from “growthier” or riskier names.
• Dividend stocks. Companies that pay dividends also seem to perk up as rates are rising, and many are typically value stocks, too.
• The S&P 500 index. Stocks often decline at first as the market prices in higher rates, but it’s key to remember that rates are usually rising because the economy is robust and companies are doing well. So, a diversified set of stocks can also rise as rates are climbing higher.
• Short-term government bonds. Yes, rising rates hurt bonds, but very short-term bonds feel minimal negative effects and the yield of new issues climbs as rates rise. Combine it with government backing and you have about as safe an investment as you’ll find.

While stocks may offer the most upside over time, investors sometimes need access to the safety of bonds – yes, even amid rising rates. That’s why it’s important to have a “go-to” bond ETF with low downside and the prospect of an annual yield, too.

Best ETFs for higher interest rates

The ETFs included below hail from the categories above, and they also offer a low expense ratio, helping you to minimize your out-of-pocket costs. (Data as of Oct. 20, 2023.)

1. Vanguard Value ETF (VTV)

The Vanguard Value ETF tracks the performance of the CRSP US Large Cap Value Index, a collection of big companies trading at relative discounts. With a rock-bottom expense ratio, a strong long-term record and about 20 percent exposure to financials, this fund should perform well in a rising-rate environment.

• Yield: 2.7 percent
• Expense ratio: 0.04 percent

2. Schwab US Dividend Equity ETF (SCHD)

This ETF tracks the total return of the Dow Jones U.S. Dividend 100 Index, which consists mainly of large American companies. The dividend yield sits on the high end of the scale, while the long-term track record – nearly 11 percent gains annually in the 10 years to October 2023 – suggests this ETF will continue to perform well.

• Yield: 3.7 percent
• Expense ratio: 0.06 percent

3. Vanguard S&P 500 ETF (VOO)

With a well-diversified portfolio of stocks from every major sector of the economy, the Vanguard S&P 500 tracks its namesake index and offers a strong, long-term record of performance. Also, a low expense ratio won’t take away much of your returns, which averaged more than 11 percent annually over the last decade.

• Yield: 1.6 percent
• Expense ratio: 0.03 percent

4. Goldman Sachs Access Treasury 0-1 Year ETF (GBIL)

Yes, a bond fund makes its appearance here, not because it’s going to provide stellar returns, but because it can fill a niche in your portfolio when you need a good, safe place to park cash. With investments in very short-term U.S. Treasury bills, this ETF will shrug off rising rates (unlike funds in longer-dated bonds), and its yield moves higher as rates rise. This fund is backed by the U.S. government, so it’s about as safe as bonds get.

• Yield: 3.9 percent
• Expense ratio: 0.12 percent

5. Invesco S&P SmallCap Value with Momentum ETF (XSVM)

This Invesco ETF often hits Bankrate’s list of best small-cap ETFs due to its attractive long-term performance, which has averaged more than 11 percent over the last decade. The fund invests in the stocks that comprise the S&P 600 High Momentum Value Index, a group of 120 value-priced small stocks that show strong price momentum.

• Yield: 1.5 percent
• Expense ratio: 0.36 percent

6. Financial Select Sector SPDR Fund (XLF)

If you want concentrated exposure to financial companies in the S&P 500, you can do that with the Financial Select Sector SPDR Fund. It offers exposure to not just banks but companies in diversified financial services, capital markets, insurance and consumer finance, among others. The low expense ratio, exposure to larger financial players and annual returns near 9 percent over the last decade give you reasons to consider this narrowly diversified ETF.

• Yield: 2 percent
• Expense ratio: 0.10 percent

7. Vanguard High Dividend Yield ETF (VYM)

The Vanguard High Dividend Yield ETF tracks the performance of the FTSE High Dividend Yield Index, which includes hundreds of larger companies. This ETF pays a substantial yield, and with about 20 percent of the fund invested in financial services companies, rising rates may offer an extra tailwind to this portion of the portfolio.

• Yield: 3.3 percent
• Expense ratio: 0.06 percent

Bottom line

Whether you go with one or more of these ETFs or another entirely, it’s important to remember that investing in stocks requires you to invest long term, at least three to five years out. With that kind of time frame, you can ride out the volatility in the market and potentially enjoy some of the attractive long-term returns that stocks can offer.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.