Two Strategies to Deal with the Unknown of when Rates will Rise
Despite collective wisdom that historically low rates will eventually rise, there no way of telling when. Because of low returns, we see individuals taking two approaches to their fixed-income investing.
The first is keeping money in low-yield savings accounts, with the belief that we can invest these funds when rates get back to ‘normal.’ Staying liquid however does not cover the risks of continued low-rates.
The second approach is to invest in higher-yielding bond mutual funds. This approach in a rising rate environment could result in lower returns as rates rise and the portfolio of bonds declines in value.
Below are two strategies to plan for rising rates, while also considering the chance of continued low-rates:
Bond / CD Ladder. A ladder allows you to receive higher average rates today, and participate in rate hikes along the way. Having 15-33% of your savings mature each year over several years allows you to earn a higher average rate today and allows you to participate in higher rates along the way. Each year as your CDs or bonds mature, you participate in rising rates by reinvesting at future rates.
Dollar-cost average. We recommend bond ladders for our retirees as a way to create a pension, and integrate their portfolio with cash needs. Instead of placing all of your money into a ladder today, average in over time. This strategy involves purchase bonds that mature over several years (we eventually like to see 15 years of a bond ladder). Next year, purchase more bonds with the same maturities. Should rates rise, the average rates of your bonds will be higher than going all in today.
The two approaches above allow for higher average rates today, and the opportunity to invest at higher rates in the future.