How to capture the increasing returns of CDs
If you’re a CD fan, the best way to play these fixed income investments now is to only lock your money into short-term CDs, such as those that mature in three, six, or 12 months. When the Fed periodically raises rates, you can replace your short-term, maturing CDs with new, higher-yielding CDs, Schlossberg explains. âYou appreciate the higher rate increases,â he says. “If you consider that over the next two or three years you would expect rates to rise steadily, over time those returns will look more attractive.” It also makes no sense to lock in a three-year CD which the FDIC says now averages 0.81 percent if the Fed’s key rate is on track to yield more than that by the end. of the year 2022.
One strategy to consider if you want to take advantage of a series of rate hikes is to stagger your CDs. Buy a three-month, six-month, and 12-month CD, and when the first CD expires after three months, you can reinvest the money into a one-year CD, which will pay more than the three-month CD. The other two CDs will be three and six months closer to maturity. And when they mature, you can turn them into a one-year CD as well.
Bondholders: short-term pain for long-term gain
Since there is an inverse relationship between a bond’s price and its yield, the bad news is that your bonds will fall in value when interest rates rise, resulting in short-term losses. âWhen rates go up, the value of your bonds goes down,â says Eric Freedman, chief investment officer at US Bank Wealth Management.
But that doesn’t mean you should ditch bonds, which provide income and diversification for your entire portfolio. The good news is that in the long run, your capital loss will be offset by higher income payments. And, just like with CDs, this means that if you own individual bonds, you will be able to buy new bonds with higher yields or convert the money you receive from maturing bonds into bonds with higher yields. âYou have to be able to take the pain in the short term for long term gain,â says Bill Schwartz, Managing Director and Certified Financial Planner at Wealthspire Advisors. This is because rising rates will soon become a tailwind for your portfolio, as you will no longer face the risk of reinvesting money at lower interest rates.
And your chances of losing a lot of money on less volatile bonds are much lower than they would be with stocks, notes Brian Andrew, chief investment officer at Johnson Financial Group. Since 1926, government bonds have suffered losses in just 10 percent of 12-month holding periods (and the average loss was only 1.7 percent), according to investment firm UBS . And bonds suffered losses in just 0.4% of three-year periods. âWhen bonds mature, income is generated and cash flow is reinvested at higher rates,â says Andrew. âSo being in a bond fund is a good thing. ”
Borrowers Beware: Costs Rise
If you borrow money, your interest charges will rise on items tied to the Fed’s key rate, such as variable rate mortgages (ARMs), home equity lines of credit (HELOC), loans automobiles and credit cards. âAll of those things that you borrow to buy will cost more,â says Schwartz. “Maybe the biggest house you were going to buy at 3.25 percent might not be affordable at 4 or 5 percent.”
And if you have credit card debt, expect to pay more interest as well. âHigher rates are just another form of inflation,â says McBride of Bankrate. âIt eats away at disposable income and paying down debt takes more work. But there are ways to avoid paying more interest even as the Fed continues its rate-tightening cycle. If you have a credit card, for example, the best way to keep interest costs down is to pay off your debt as soon as possible, says Ross Mayfield, investment strategy analyst at Baird.
If you have an ARM or HELOC, mortgage products whose interest rates are rising at the same rate as the Fed rate hikes, it might be a good idea to lock in on a fixed rate mortgage now before the first rate hike. Fed rate, which could occur as early as March. , adds McBride of Bankrate.
âRefinancing is always great now,â says McBride. âAnd, especially for seniors living on fixed incomes who see inflation increasing their costs, the ability to refinance their mortgage to reduce their monthly payment amount provides flexibility in their budgets.â
It turns out that rate hikes aren’t the end of the world. And it’s important to keep news of the Fed’s pivot to higher rates in perspective, says Andy Smith, executive director of financial planning at Edelman Financial Engines. âTry to make sure that (you) get into it the right way and take away as much emotion as possible,â Smith says. This means making adjustments here and there to take advantage of higher savings rates or lower your borrowing costs, but keeping your investment portfolio for the long term, which should include both stocks and bonds, on. the autopilot.