Cash, bonds and rising interest rates
This month is a little longer than usual as I try to explain several complex, interconnected topics in a digestible way. If you don’t read it all, at least check out the charts at the end. 😊
One of the biggest challenges since the Federal Reserve started cutting interest rates to stimulate the economy following the 2008 Great Recession, has been getting a decent return on conservative money. While the stock market has done great after dropping about 50% in 2008-2009, low interest rates have suppressed returns on the conservative side of any portfolio.
With a recovering economy the Fed started raising rates at the end of 2015 from 0.25% to the current rate of 2.0%, projected to go to 2.5% by the end of this year. Rising rates have had both good and bad effects on the two most popular conservative investments, cash and bonds (some may throw annuities and other tools into this camp, but that’s a topic for another day).
Cash: Rising rates have been a good thing for cash as you can now actually earn something. I often encourage people to keep a reserve of cash and a good place to do so is an FDIC insured online savings account, where you can currently earn almost 2% (or slightly more with a short- term CD), which isn’t huge but beats the 0.09% you’ve probably been earning at your local bank. You can compare banks at Bankrate and a couple that I’ve had good experiences with include Ally and CIT.
Bonds: When you buy a bond you lend money and earn interest for doing so. Bonds come in many forms, the main components determining the interest rate are term and credit. Term is the length of the bond (how long you’re loaning the money, the longer the term the higher the risk) and credit is the credit worthiness of the issuer (treasury bonds issued by the US government are the most secure, on down to issuers such as Tesla, who’s bonds now have junk bond, or high-risk status). Since bonds are designed to be the buoy in your portfolio I generally recommend shorter term, higher credit rated bonds. The downside to raising interest rates is that it actually hurts bond prices. This is because since you can now buy bonds paying more interest, your lower interest bonds become less valuable. Of course, you can hold onto bonds until they mature, but there is an opportunity cost in doing so. Higher rates are better in the long run as new bonds purchased pay a better rate, however, the bonds you currently own drop in value.
1 - If you have cash sitting around earning close to nothing, consider an FDIC insured online savings bank. The experience my clients and I have had with these accounts has been positive.
2 - Don’t abandon an appropriate investment strategy. All too often I see people follow the crowd and chase performance. We even do this unknowingly or slowly over time. In the decade of 2000-2010 bonds beat stocks and people questioned if they should invest in stocks at all since bonds performed better with much less volatility. Now almost 10 years later, people are saying just the opposite since stocks have had a huge rally and bonds have had little growth and even gone down in some cases (YTD 2018 for example). Timing when to jump back and forth from stocks to bonds is nearly impossible, instead, remind yourself of the purpose of your investments (retirement income, college, home purchase, etc.) and build a strategic balance of stocks and bonds around that. If you’d like to discuss what an appropriate mix for you may be, email me at advisor@blakegallion to set up a complimentary appointment.
Take a look at the charts below showing the returns of cash, bonds and stocks. I think they tell a compelling story.
The “lost decade for stocks” of Jan. 1, 2000 – Dec. 31, 2009
The bull market experienced from Jan. 1, 2010 – June 30, 2018
The combined period of Jan. 1, 2000 – June 30, 2018
Charts from Portfolio Analytics.
The Barclays US Aggregate Bond Index is an unmanaged index considered representative of the U.S. investment-grade, fixed-rate bond market. The S&P 500 Index is an unmanaged index considered representative of the U.S stock market.
The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Past performance does not guarantee future results.
Advisory services offered through Arbor Point Advisors. Securities offered through Securities America Inc., Member FINRA/SIPC. Arbor Point and Securities America are separate companies. CA Insurance #0E88557