Investors shouldn't expect the plump yields they've been enjoying all year to continue. If you want big yields on your cash, you need to move now on savings rates.
Yields on many bonds are already sinking. And the Federal Reserve has signaled three rate cuts in 2024 which will shrink the interest savers earn on cash. "Yields aren't going to get better," said Greg McBride, chief financial analyst at Bankrate.com.
Savers and retirees must implement a new game plan to keep their income stream from shrinking too much. The goal now for fixed-income investors is to try to lock in higher yields for longer.
Here are a few ways to make your cash work harder for you as interest rates reset lower.
Don't Obsess Over The Fed's Moves With Savings Rates
Fed talk is just talk — for now. Sure, the Fed has hinted at rate cuts. "But the Fed hasn't changed monetary policy yet," said Sam Millette, director of fixed income at Commonwealth Financial Network.
The take-away: rates tied to the Fed's key lending rate, such as money market accounts and certificates of deposit (CDs), won't budge until the Fed starts to slash rates. And if the central bank reduces rates, these types of cash investments will move down gradually and in lockstep with the Fed's moves.
So, for each quarter of a percentage point Fed rate cut, your cash will earn 25 basis points less. Let's say the Fed lowers rates by three quarters of a percentage point next year: your money market account that currently earns 5% may fall to 4.25%. Not horrible, but not as good of a return that you were getting at peak rates.
Silver Lining To Lower Savings Rates?
The good news is that until the Fed starts to ease, you'll still be able to buy top-yielding CDs at current high yields. Those rates range from 5.5% for a one-year CD to 4.9% for a five-year CD, and you'll still earn roughly 5% on a money market account, according to data from Bankrate.com.
The downside, of course, is income streams that aren't locked in, such as money markets, will start to shrink once the Fed starts cutting. So, a year from now you might not be able to reinvest in a one-year CD and still get 5.5%.
"Cash has been a great place to hide out, but now that the Fed has said they're open to cutting rates, that means you can't extrapolate that 5% return (out into the future)," said Jack McIntyre, a global fixed income portfolio manager at Brandywine Global.
Lock In For Longer
You can counter the effects of sinking rates by securing current high rates before the Fed starts its rate-cut cycle.
One way to do that is to buy a CD. "Now's the time to lock in," said McBride. "If you're a retiree or approaching retirement or someone looking to set up a predictable stream of interest income, now's the time to be locking in the high-yielding CDs."
McBride recommends creating a CD ladder in which you invest a set amount of dollars in CDs that mature in one, two, three, four and five years. You can still lock in top-yielding one-year CDs at 5.5%, a two-year CD at 5.25%, and earn 4.9% on three-, four- and five-year CDs, he said.
How CD Ladders Can Pay Off With Saving Rates
The benefits of a CD ladder in a falling-rate environment are many. You can earn a predictable stream of interest over a five-year period. You know exactly how much you will earn in interest. Your real return will increase if inflation, currently at 3.1%, continues to fall. And, more important, you can access your capital each year as one of the CDs in the ladder matures.
The key to making this strategy really pay off is to do your research and buy CDs that offer the highest yields.
"Shop around," McBride said. "I can't emphasize that enough because shopping around is going to get you some of the best yields we've seen in 15 years."
The difference between the top-yielding one-year CD on Bankrate, which is 5.65%, compared to the 0.03% offered by Bank of America and 0.01% offered by JPMorgan Chase is huge.
Go Long If You Can
You can also boost yield with longer-duration bond investments.
Remember, there is an inverse relationship between a bond's price and its yield. So, if yields fall, that means prices rise. You can benefit from capital appreciation on the bonds you own, on top of the yield they pay out. For the past year, most investors have been focused mainly on the yield component of a bond's return.
Intermediate bonds, which have maturity dates between two and 10 years, and longer-term bonds with maturities exceeding 10 years, are more interest rate sensitive. So, in a falling rate environment, owning bonds with longer duration can boost total returns.
These types of longer-term bonds with longer duration maturities now look attractive, says Ed Perks, chief investment officer of Franklin Income Investors. "While cash continues to offer some yield, if there's a change in (Fed) rate policy (and rates fall), cash investors would be left in the dust sitting on too much short duration (which will experience lower yields if the Fed cuts rates)."
Pump Up Bond Returns
Here are a few ways to earn more total return on your bond investments.
Millette recommends investing in intermediate bonds, which offers a good mix of current high yields and less interest rate risk than a longer-term bond. He says investors should consider an intermediate bond fund that tracks the broad Bloomberg U.S. Aggregate Bond Index.
He describes the math this way: The Bloomberg U.S. Aggregate, which has a duration of roughly 6.25 years, now yields about 4.65%. So, if rates fall one percentage point, you'll earn 6.25% in capital appreciation. "You earn that positive price return on top of the yield you're already planning on earning," said Millette. So, your total return, using a rough back of the envelope calculation, would be a 10%-plus return, says Millette.
"This total return opportunity is really one of the silver linings of the pain that we felt in 2023 (when rates were rising and prices were falling)," said Millette.
There's Nothing Average About Intermediate
Investing in a core intermediate bond fund like the Bloomberg U.S. Aggregate will give you a smoother and less volatile ride than investing in say, a 10-year or 30-year Treasury, he adds.
Since it's still unclear whether the Fed will be able to engineer a soft landing and avoid a recession, McIntyre prefers adding duration to a bond portfolio in U.S. Treasuries.
A 10-year Treasury, for example, not only fetches a still-competitive yield of 3.9%, despite a big rally that has brought its yield down from 5%, but it also offers downside risk in the event a recession occurs due to higher borrowing costs, says McIntyre. "Treasuries are going to hold up well," said McIntyre, as well as function as a safe haven in the event of an economic contraction.
Tapping Treasuries
Investors might also consider investing in a five-year or seven-year Treasury, which currently yield 3.89% and 3.92%, respectively. McIntyre thinks yields on the short-end of the yield curve, or shorter-term bonds, will come down faster than longer-duration bonds. In addition, you won't have to lock your money up for as long a time. "That's the optimal place to be," said McIntyre.
Treasuries also will offer a total return opportunity if rates fall.
With the economic outlook still uncertain, McIntyre also advises investors to stay diversified with their fixed-income holdings.
Overall, the income outlook remains positive for investors who want their cash to work harder for them.
"We don't expect near-term rate cuts but believe bond yields should move modestly lower throughout 2024," said Anders Persson, chief investment officer for global fixed income at Nuveen, and investment manager of TIAA.
