Oh boy- short-term interest rates are up! What are the pros and cons of short-term fixed income investments, and how can I help?
Short-term fixed income investments such as CDs, treasuries, and money markets, either owned individually or through a short-term bond fund are a critical part of an overall asset management strategy.
Any cash you need for 1-3 years should be in cash and short-term fixed income, which I’ll call ST-FIto be brief.
WHY? Cash builds a “moat” of defense around your long-term investments. If you have plenty of cash and ST-FI, you may avoid selling investments at a bad time in order to get cash!
It’s nice to be able to earn a little interest on money that you’ll need soon to replenish your checking account, make a down payment, or for other planned expenses.
The drawback of ST-FI: reinvestment risk. Once inflation goes down, so may interest rates. We already see it priced into longer-term fixed income investments.
If you need to accumulate and compound for the long-term, once your 4.5% CD comes due at the bank, what good option will you have?
Once interest rates stop rising or even decline, the equity market may be ready to resume its long-term upward trend.
You could miss out on a dynamic rebound in the stock market while you’re earning your 4.5% APR.
Heck, as of May 1 the S&P 500 is already up 9% for the year!
Doing some financial planning for retirement can help drive home that some amount of long-term growth through capital appreciation and compounding dividends is crucial to financial success.
This understanding can be critical during times when you might be tempted to temporarily move your long-term portfolio to “safer” investments like CDs and cash.
If you own only ST-FI, after taxes and normal 2-3% annual inflation, are you preserving purchasing power?
Historically a long-term investment strategy keeps pace with taxes, inflation, and then some. The S&P 500 has averaged a 10% return annually over time periods corresponding to our lifetimes, although this is not guaranteed.
Imagine a simplified hypothetical: you own shares of Coca Cola. You spent $10,000 and bought about 360 shares in the year 2000. You watched the value go up and down, but today your 360 shares are worth $25,000, plus they pay out nearly $700 in dividends each year, which can be reinvested or taken to the bank to pay the bills. Does anyone worry that Coca Cola might go out of business?
On the other hand, you lend by buying a bond or CD: $10,000 reinvested at 3% annually would be $19,700 in 23 years. If you took out the $300 interest each year to pay bills, you would just have $10,000 23 years later.
Does anyone doubt that the $10,000 will buy much less than it did 23 years ago?
In the owner versus loaner debate, let’s take a hint from CEOs and their boards. If they did not run their business in such a way that the cost of paying interest to borrow capital was not eclipsed by the potential for increased value and profits for stock holders- they wouldn’t do it! Who may have the better end of the deal in the long run?
This is why advisors are here: to challenge the idea that investing in ST-FI alone is “safer” than stocks- when our idea of safety is not running out of money.
Time frames for these accumulation and compounding strategies should be LONG- not only during your working years, but throughout the decades of retirement.
Content in this material is for general information only and not intended to provide specific
advice or recommendations for any individual. All performance referenced is historical and is no
guarantee of future results.
Investing involves risk including the loss of principal. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price. Certificates of Deposit are FDIC insured and offer a fixed rate of return if held to maturity. Brokered CDs sold prior to maturity in the secondary market may result in loss of principal due to fluctuations in the interest rate or lack of liquidity. Brokered CDs are registered with the Depository Trust Corp. (“DTC”). Brokered CDs with step-down and/or call provisions may be less favorable than traditional CDs without these features.
Historical adjusted stock prices found on yahoo.com. Reference to markets is an index which is unmanaged and may not be invested into directly.
Securities and Retirement Plan Consulting Program services offered through LPL Financial, a
Registered Investment Advisor. Member FINRA/SIPC. Investment Advice offered through Western Wealth
Management LLC, a Registered Investment Advisor. LPL Financial, Kennebec Wealth Management LLC and Western Wealth Management LLC are separate entities.