There are many strategies for investment income, but during this time of uncertainty with seesawing market, high inflation and the possibility of more interest-rate increases, some investors want safety more than anything else.
If you want to protect your money and take best advantage of current interest rates while lowering your risk of having to make subsequent investments at lower rates, laddering a portfolio of bonds and bank certificates of deposits may work out well.
Ken Roberts, an investment adviser with Four Star Wealth Management in Reno, Nev., suggested doing this through U.S. Treasury securities and certificates of deposits at banks.
” You are sticking with high credit quality — the full faith and credit of the federal government for Treasury securities and FDIC insurance for the CD deposits,” he said during an interview.
And it is easy to shop around for higher CD rates through your brokerage account or with the help of a financial adviser, while using the same platform to purchase Treasury securities.
Bank CDs are covered in the U.S. by the Federal Deposit Insurance Corp. up to certain limits (described here).
And if you are worried about exceeding FDIC deposit insurance limits, Quentin Fottrell has useful advice.
If safety is your paramount concern, the reason you should hold your own bonds, rather than shares of a bond fund, is that you know how much you will receive when a bond matures. If interest rates rise after you buy a bond, its market value will go down, and vice versa. So if you buy a bond and are forced to sell it after rates rise, you will take a capital loss. But if you hold a bond until maturity you will be paid its face value.
A bond’s face value is known as its “par” value. If you were to pay a 1% premium for a bond, for example, we would say you had paid 101. If your price were discounted by 1%, we would say you had paid 99.
In the current market, if you were to buy U.S. Treasury securities with six-month, 1-year or 2-year maturities, you would pay discounted prices. You can see the pricing at The Wall Street Journal’s U.S. Treasury Quotes page.
To see why your ladder should protect you from interest rate risk, take a look at the yields, as of the close on April 12, for various maturities of U.S. Treasury securities:
|U.S. Treasury security maturity||Symbol||April 12 yield|
|Source: Daily U.S. Treasury Par Yield Curve Rates|
You can click the Treasury securities’ symbols in the table for more information.
Click here for Tomi Kilgore’s detailed guide to the wealth of information available for free on the MarketWatch quote page.
It might seem strange that the yield curve is inverted. But it indicates professional investors expect a recession and have loaded up on longer-term bonds, pushing up their prices and lowering their yields. If the U.S. economy were to begin to shrink, after the Federal Reserve’s policy to raise interest rates to clamp down on inflation, the central bank would be forced to reverse its policy. Declining interest rates would cause long-term bond prices to soar and enable investors to book profits.
And that underlines the interest-rate risk. The highest-yielding maturity indicated by the Treasury yield curve is only three months. But if you park all your money at that maturity to earn the highest interest rate over the short term, you might be forced quickly to reinvest at lower rates if and when the economy slows down.
Maybe a “sweet spot” for your maturity is six months or a year. Or maybe locking in longer maturities is a good idea. Consider that two years ago, 2-year Treasury notes yielded only 0.15%. And the economy was growing at that time. Imagine how easily rates could fall near to zero if the economy were to begin to shrink.
Right now (that is, on April 13), you can get these annual percentage yields (APY, reflecting compound interest) for CDs at one of the largest U.S. brokerage firms:
|CD Maturity||Annual percentage yield|
Note that the some of the CD yields are much higher than the Treasury yields for the same maturities. Income from U.S. Treasury securities is exempt from state and local income taxes, so this is another factor to consider.
Roberts a five-bucket ladder for a good combination of U.S. Treasury securities and CDs for protection of capital and a hedge against interest-rate risk:
- 20% in six-month U.S. Treasury securities at 4.98%.
- 20% in a one-year CD at 4.95%.
- 20% in a two-year CD at 4.80%.
- 20% in a three-year CD at 4.55%.
- 20% in a five-year CD at 4.40%.
“If interest rates keep rising, you will have the opportunity to reinvest at higher rates. If rates fall, you will have some higher rates locked-in,” he said.
Roberts added that ladders can be adjusted over time. “You can structure a ladder to fit your needs,” he said.