The Rising Interest Rate Environment
When inflation rates are on the rise, traditional savings and minimal money market account yields are simply unable to keep pace. But the prospect of purchasing longer-term investments like 10-year Treasury bills can be equally problematic— potentially locking you into a lower yield while interest rates continue to climb.
The question therefore is: what are some cash alternatives to consider that have the potential to deliver enough yield to help keep pace with inflation, without tying your money up too long in case rates continue to rise?
Solutions to Consider
Generally, when interest rates are rising, investors tend to reduce their overall exposure to longer-term bonds, which tends to be more sensitive to rising rates. Often, this may be accomplished by considering cash alternatives to help better position your portfolio to adapt to a rapidly changing rate environment:
- Brokered Certificates of Deposit (CD's) - Brokered CDs are debt obligations of an issuing bank with a coupon rate and set maturity. Brokered CDs are issued by banks and then purchased or distributed in bulk by wealth management firms, like Janney, who, in turn, sell them to clients through their Financial Advisor networks. Because firms are able to invest a much larger sum with the issuing bank than an individual investor, it’s often able to offer a higher interest rate. The FDIC insures individual depositors for up to $250,000 per issuer bank.1 Brokered CDs also generally offer you more flexibility because you may sell them before maturity, depending on market conditions.
- Short Term Bonds - Fixed income securities with lower average durations (one to four years) compared to intermediate or long-term bonds. Yields on shorter-term bonds, however, are typically lower than yields earned on longer-term bonds.
- Floating Rate Notes (FRNs) - Relatively short-term investments (two five-year maturities) with a variable interest rate that typically resets every three or six months—allowing them to keep pace with rising rates. Be aware, however, that they contain some credit risk. FRNs pay interest every three months, and you can either hold them until maturity or sell them before they mature.
- Treasury Inflation Protection Securities (TIPS) - Offer an inflation-adjusted rate of return that deliver the purest hedge against rising inflation. Unlike other Treasury securities, where the principal is fixed, the principal value of a TIPS can rise to keep pace with inflation. And since TIPS are issued by the U.S. Treasury, they’re also considered one of the relatively safer investments available.
How Bond Laddering Works
Another investment strategy to consider when looking to generate income during a rising rate environment is the practice of ‘bond laddering’—building a portfolio of individual bonds or CDs that mature on different staggered dates over a period of time. By spreading out the maturity dates of your holdings, you’re able to help minimize your exposure to rising interest rates, while generating a predictable income stream at the same time.
Laddering your bonds so they mature periodically at future intervals allows you to regularly reinvest proceeds at higher yields whenever interest rates are climbing. For instance, if you have $100,000 to invest in a bond portfolio—instead of buying a single $100,000 bond with a single interest rate and maturity, you may want to consider spreading that investment over different maturities with different interest rates, like the following example illustrates:
After a year, you then have the choice to take the maturing $20,000 from the first bond and reinvest it in a new 10-year bond that would mature one year after the existing 10- year bond in your portfolio, redeploy it into a completely different investment, or use it for income.
We’re Here To Help
How high interest rates will ultimately climb and for how long they’ll remain elevated is as unknowable as the future movements of the financial markets. Yet even in this current economic, market, and interest rate environment, you have access to a number of alternatives to the near-zero rates on offer through traditional savings vehicles. If you have cash on hand that you’re ready to deploy, we can help you explore the various strategies and understand what may be appropriate for your own portfolio.
Working With Janney
Depending on your financial needs and personal preferences, you may opt to engage in a brokerage relationship, an advisory relationship or a combination of both. Each time you open an account, we will make recommendations on which type of relationship is in your best interest based on the information you provide when you complete or update your client profile.
When you engage in an advisory relationship, you will pay an asset-based fee which encompasses, among other things, a defined investment strategy, ongoing monitoring, and performance reporting. Your Financial Advisor will serve in a fiduciary capacity for your advisory accounts.
For more information about Janney, please see Janney’s Relationship Summary (Form CRS) on www.janney.com/crs which details all material facts about the scope and terms of our relationship with you and any potential conflicts of interest.
By establishing a relationship with us, we can build a tailored financial plan and make recommendations about solutions that are aligned with your best interest and unique needs, goals, and preferences.
Contact us today to discuss how we can put a plan in place designed to help you reach your financial goals.
1. Federal Deposit Insurance Corporation National Averages, October 2022
The examples provided are all hypothetical and do not take into account any specific situations. The hypothetical examples are provided to help illustrate the concepts discussed throughout and do not consider the effect of fees, expenses, or other costs that will effect investing outcomes. Any actual performance results will differ from the hypothetical situations illustrated here. Please consult a professional to help you evaluate your situation before implementing any of the strategies discussed here.
Janney Montgomery Scott LLC, its affiliates, and its employees are not in the business of providing tax, regulatory, accounting, or legal advice. These materials and any tax-related statements are not intended or written to be used, and cannot be used or relied upon, by any taxpayer for the purpose of avoiding tax penalties. Any such taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor.