After months of high interest rates, the economic tides appear to be shifting.
Experts largely expect the Federal Reserve to slash interest rates during the central bank’s meeting on Wednesday, a reversal of a rate-hiking policy aimed at taming post-pandemic era inflation.
For consumers, declining short-term interest rates will come as a relief. When the Fed’s benchmark rate falls, the cost of mortgages, credit cards and other loans tend to become significantly cheaper.
If you’re saving for a short- or intermediate-term goal, however, the Fed’s upcoming move is bad news. That’s because lower rates mean earning less on interest-paying vehicles such as bonds, cash accounts and certificates of deposit.
For now, there’s still plenty of yield to be had. Versions of all three vehicles currently offer guaranteed interest rates north of 5%.
That means, for certain savers, now may be the last opportunity to lock in a relatively high interest rate on short- to medium-term investments, says Amy Arnott, a portfolio strategist with Morningstar Research Services.
“It makes sense, especially if you’re trying to save for a specific goal,” she says. “You could hold a bond with a maturity that matches the timing of your goal.”
Why it makes sense to lock in higher rates now
For years, when interest rates were near zero, it was hard to earn practically anything on a short-term bond or cash account.
“For the past couple of years, we’ve had higher yields available on very short-term securities, like cash,” says Arnott. And although you can still get north of 5% on a short-term Treasury bill, she says, “eventually, that will decline.”
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Given the widely held outlook that Fed rate cuts will happen sooner rather than later, there’s a compelling case for locking in an attractive rate of return by investing in bonds, says Christopher R. Jackson, senior vice president of UBS Wealth Management.
“It’s pretty easy to get 5% or 6% in high-quality bonds with a 5- or 10-year maturity, which is a contractual return,” he says. “That’s probably not a whole lot less than what we would expect from stocks over the next five to 10 years, with a whole lot less risk.”
How to invest for short- and medium-term goals
A quick reminder on how bonds work. When buying a bond, you effectively loan money to a business or government. You agree to a certain amount of time they can hang on to your money and an interest rate you’ll be paid, known as a bond’s coupon. You receive interest payments at predetermined intervals, and when the time period ends (the bond reaching maturity), you get your principal back.
Typically, the more risk a bond carries, the higher the interest you can earn. Bonds issued by low-quality companies often pay handsome rates, but carry a high risk of default, hence their nickname, “junk bonds.”
Jackson currently favors highly rated debt issued by corporations, which tends to yield more than similarly dated government debt. These may not be a terrific buy for retail investors, though, says Arnott.
“For the average individual investor, you would probably want to buy Treasurys instead of corporates, because you would have to do a lot of additional research to make sure you’re not taking on too much credit risk [to buy corporate bonds],” she says. “And then you would also want to have a diversified portfolio of corporate bonds, which could involve a lot of extra complexity.”
Treasury bonds are backed by the U.S. government, and therefore carry virtually no risk of default. Buying one, either directly from the Treasury or through your brokerage account, guarantees you a locked-in return over the period you select.
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