The Silver Lining of Higher Interest Rates: Cash and Bond Yield Strategies to Implement Now

 

 

Much has been written and discussed regarding the rise in interest rates and inflation so far in 2022.  As data is published each month showing continually elevated inflation, it appears this new paradigm of higher rates may be here to stay.  

Despite the market reaction this year, there is a silver lining to higher interest rates.  While no one enjoys the decline in bond prices that come with rising rates, higher rates themselves do allow investors to enjoy an improved yield on many types of fixed-income assets such as cash and bonds.  

For much of the last decade, these fixed income assets have paid zero, or near zero, requiring investors to seek additional risk for the same amount of income- a practice known as “reaching for yield.”

Now, after the significant increase in yields we’ve seen in 2022, even the safest investments can produce meaningful amounts of income.  For example, high-yield savings accounts offer around 3%, and US treasuries with a maturity of just two years yield over 4.5%.  For those in or near retirement, the old “4% withdrawal” rule of thumb seems more plausible if safe bonds pay that 4% without incurring unnecessary equity risk. 1  

In other words, while the path to get to a higher interest rate environment has been painful in the short-term, it has created an opportunity to invest at those higher rates!  Investors with cash surpluses can now earn real income on their cash, and bond investors can invest at higher rates today that may continue to increase over time with a properly structured bond portfolio. 

One technique bond investors can use to do that is to invest in a bond ladder.  Rather than purchasing long-term bonds and locking in an interest rate for years, bond laddering aims to hedge the continued risk of rising rates by purchasing multiple short-term bonds that mature periodically at different times.  The proceeds from the maturing bonds can then be reinvested in a new bond in the future, which would trade at higher yields if rates continue to rise. 

Other opportunities in fixed income include CDs, municipal bonds for tax efficiency, Treasury Inflation-Protected Securities (TIPs), and i-Bonds.  Evaluating which of these is appropriate depends on the risk and return considerations of the investor.  At Wright Wealth we can help think through the pros and cons of various income-producing investments and how they might fit into your portfolio and overall cash flow needs.  Contact us or schedule a call today to learn more.

1.      The 4% withdrawal rule is a simple framework, based on historic market analysis that suggests that withdrawing 4% of an investment portfolio each year is sustainable in retirement.