When short-term CDs, Treasury bills, and money market funds are paying attractive rates, it is tempting to keep all of your fixed income in short-term investments. Why tie money up for five or ten years when you can earn a competitive rate for six months? It is a fair question, and there are good reasons to own some longer-term fixed income anyway.
Short-term rates can change quickly
The rate on a six-month CD or a money market fund only lasts until the next maturity or the next rate change. If rates fall, you will have to reinvest at whatever the market is offering at that time. This is called reinvestment risk, and it is easy to overlook when short-term rates are high.
Five reasons to lock in longer-term rates
- Stability and predictability. A longer-term CD or bond gives you a clear picture of your interest income for years, which makes it easier to plan retirement cash flow.
- Protection if rates decline. If you expect rates to fall, locking in a rate today keeps your income from falling with them.
- A possible hedge against inflation. When longer-term rates are above the rate of inflation, locking them in can help preserve your purchasing power over the term.
- Matching long-term goals. If you know you will need money for a specific goal years from now, such as funding a portion of retirement or a grandchild’s education, a maturity date that lines up with that goal can make sense.
- Diversification. Owning a mix of short, intermediate, and long maturities spreads your interest rate risk rather than betting everything on one direction.
Consider a ladder
If you are unsure where rates are headed, you don’t have to choose between all short-term and all long-term. A ladder spreads your money across several maturities, for example one to five years. As each rung matures, you reinvest it at the long end. You always have money coming due for flexibility, and part of your portfolio is always locked in at longer-term rates.
Understand the risks
CDs are FDIC-insured up to applicable limits and pay a fixed rate if held to maturity, but withdrawing early usually means a penalty. Bonds and bond funds can lose value if interest rates rise and you sell before maturity. Longer maturities are more sensitive to rate changes.
The right mix depends on your goals, your need for liquidity, and your tolerance for risk. If you would like help figuring out where different fixed income investments fit in your plan, please reach out.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
