The 3 Best Ways to Hedge Against Higher Interest Rates

It has been a stock-versus-stock world for a long time. Investors and traders have obsessed over which sectors, geographic regions, themes, or fads to invest their hard-earned money into. But the more I look at how this part of the investing cycle is playing out, I’m less interested in all of the above.

That’s not to say I’m not active in the stock market. I am, and will continue to be. In fact, I am more active in the stock market than ever and am utilizing short holding periods. 

However, I no longer trust the stock market to deliver long-term gains, at the market, sector or stock level. 

Of course some stocks and sectors will occasionally deliver the type of 50%, three-year return we want to fill our portfolios with. I just don’t think that those opportunities will be easy to find for a while. Valuations are too high, and speculation and leverage are even higher. 

So I’m a “renter” of stocks, not an “owner” of them. Until we see a major decline. And I have no idea when that will be.

I also do not know where interest rates will go. But in the same way I hedge my stock portfolio via shorter trade length, smaller position sizes, use of option collars, puts, or buying calls as a surrogate for taking bigger positions in stocks and equity ETFs, I’m looking at bonds.

My bond ladder is the biggest part of my portfolio. Why? Because at nearly a 5% yield, I believe that over the next many years, that will be a competitive return. And if it is not, it will still be a nice base return alongside whatever I can accomplish in the stock market.

But bonds carry risks too. I own U.S. Treasuries, and as such, the main risk is higher rates due to inflation or other factors. Is there a default risk, as is more synonymous with high-yield corporate bonds? I guess so. But as I see it, if the U.S. government can’t pay me back, we all have much bigger issues. 

So while the U.S. Treasury is helping to fund my retirement (since I own their bonds) alongside an eventual Social Security check I’ll receive, I am not the type of investor that sits there, earns my 4.5% to 5.0% return over time, and brush off those occasional periods where rates pop, leaving me with temporary paper losses. 

Since U.S. Treasury bonds will mature on a specific date, at 100 cents on the dollar, which secures a yield from now to maturity when you buy them, investors can have some confidence. However, since many of my bonds will not mature for several years, if rates surge higher, even for a while, that return I locked in now will be less competitive. 

I can ignore that, and take my 5%. Or, I can go a step further, and hedge my portfolio against the threat of higher interest rates. Since inflation is one common factor that produces elevated rates on bonds, we can think of hedging a bond investment as also hedging inflation risk.

How to Hedge Higher Rates

This is not a comprehensive review. However, I can at least provide a “starter kit” in the form of three different ways I do it.

One of the most direct methods for hedging rising long-term yields is utilizing specialized interest rate hedge ETFs designed to generate asymmetric returns during rate spikes. That is, if rates go up, and bond prices decline, that ETF rises in price. Against my bond ladder, there’s some hedging benefit. Naturally, that also means I have to take the hedge off, or risk seeing that profit evaporate, as the bonds recover in price.

The Simplify Interest Rate Hedge ETF (PFIX) holds over-the-counter interest rate options to accomplish this. Because PFIX acts functionally similar to holding long-dated put options on long-term Treasuries without the operational complexity of managing over-the-counter derivatives, a modest allocation can offset significant price decline in portfolios. You can see just how volatile it is here.

Alternatively, inverse Treasury ETFs like the ProShares Short 20+ Year Treasury (TBF) or leveraged versions of that same concept like the ProShares UltraShort 20+ Year Treasury (TBT) and Direxion Daily 20 Year Treasury Bear 3X ETF (TMV) provide inverse daily performance to long-term Treasury bonds. While these inverse products offer straightforward directional bets against bond prices, investors must account for daily rebalancing decay, making them tactical trading tools rather than permanent long-term holdings.

For investors seeking customized downside protection, buying put options directly on the iShares 20+ Year Treasury Bond ETF (TLT) represents a classic, capital-efficient hedge. Purchasing out-of-the-money put options on TLT establishes a defined-risk floor: the maximum loss is strictly limited to the option premium paid, while the potential gain scales exponentially if long-term yields surge and TLT experiences a deep price decline. 

For instance, the example above uses TLT puts which are struck at $80 a share. That means each contract essentially shorts TLT below $80. When I wrote this on Aug. 26, it sat at $83.30, giving me a 4% gap. But the puts only cost around $1 a share. Translation: I can hedge $8,000 worth of bond exposure for nearly four months, for $106. 

Ultimately, hedging against higher interest rates requires recognizing that every protective strategy involves tradeoffs and costs. Outright put options risk expiring worthless if yields remain range-bound, while inverse ETFs suffer from volatility drag over extended holding periods. 

The most effective approach treats rate hedging not as a speculative gamble, but as an active risk-management tool. And I’m all about risk management. I also believe that too many of my Baby Boomer peers are ignoring the opportunity in bonds or not hedging. I hope I can help you start the ball rolling with both. 

By combining a core ladder of cash-generating fixed income with a right-sized overlay of TLT put spreads or specialized rate-hedge ETFs, investors can protect portfolio capital against sudden rate spikes without sacrificing long-term compounding.

Rob Isbitts is a semi-retired CIO, former fiduciary investment advisor, and Barchart columnist. Check out his other work at ETFYourself.com (featuring the Fresh Charts weekly trading post), and ROAR.PiTrade.com, helping investors to better-manage their own portfolios.