BY CHRIS JORDAN
For many Westchester and Fairfield county preretirees, figuring out how to invest is hard enough. Balancing current needs, emergency funds, college and retirement can be overwhelming. But the recent drumbeat of higher interest rates has many investors asking, “What does this mean to me?” and “What should I be doing now with my money?”
While there are always many unknowns, it seems almost certain that higher rates are on the horizon, and taking smart steps now can have a big impact on your finances.
So why are higher rates an issue and why all the bond-related headlines? Over the past 30 years or so interest rates have done nothing but decline. When that happens, the price of bonds goes up and everyone is happy. Spoiler alert: When rates inevitably go up, the value of investors’ existing bonds go down, creating some decidedly unhappy bondholders. Regardless of the number of articles or broadcasts, undoubtedly some will be genuinely surprised when their statements trickle in. Long gone are the “buy and hold” days of the ‘90s.
A common strategy to circumvent this challenge is to create a bond ladder. A bond ladder is a series of bonds that mature at different intervals such as every three, six, nine or 12 months. As rates rise, the maturing bonds can be reinvested at the new higher rate.
For longer-term investors, now is the time to revisit your bond funds and really know what you own. Many core bond funds focus on a narrow segment of the bond market often defined by the Barclays U.S. Aggregate Bond Index. This approach worked well for years but could face tougher times ahead.
Incorporating a flexible bond fund now could be worth the time spent. These strategies differ by giving the managers the flexibility to seek opportunities or manage risk exposure by allocating across a wide range of instruments – credit qualities, durations and regions far beyond that of a basic core bond fund. Like all things these come in many different flavors, so be certain that your managers have serious capabilities in the flexible space.
For those with the right tolerance, high-yield bonds could be worth a closer look. The higher yield of these types of bonds may well compensate investors compared to lower-risk options. As always, moderation and common sense is the name of the game. Consider your 401(k) holdings to determine not only your asset mix but when you might be taking withdrawals. Many company plans have come a long way toward giving investors more options and can include “target date” funds. These funds tend to adjust your allocation as you get closer to needing your money. Typically the bond portion of the allocation is intended to diversify the risk associated with the stock portion.
So while the focus of higher rates tends to be on bonds, it’s important to look at other areas that could affect you. And not all is bleak. Rising interest rates mean that your conservative accounts like certificates of deposit and money markets will finally begin to pay you more for parking your money at the bank. After the 2008 stock market collapse, many still keep a larger percentage of cash than ever before. An emergency account is critical to any good financial plan but having too much in cash carries the risk of not earning enough. Currently the real rates of certificates of deposit, once you factor in inflation and taxes, has been negative.
Finally, this might be your last shot to lock in your mortgage at truly bargain rates. If you are thinking about buying a home or refinancing your mortgage, now is time. Talk to a loan officer and crunch your numbers as this alone could be a windfall prior to rising rates.
The impact of the Fed raising rates has numerous implications but for many the focus is on their bond or fixed income portfolios. To better understand how your portfolio might react is the first step in taking control. By understanding your options now you can easily take steps to position yourself for changes ahead.
Chris Jordan is the CEO of LEXCO Wealth Management Inc., a registered investment advisory of 33 professionals managing more than $1.3 billion in client assets, based in Tarrytown with an office in Greenwich.