The 21st century will see steadily decreasing interest rates. The benchmark US federal funds rate was 6% at the start of 2000. It stood at 0.09% as of December 2020. The Federal Reserve, which sets monetary policy in the United States of America, states that rates will stay close to zero until at least 2023.The fed funds rate is the benchmark for interest rates that lenders and investors charge. Low interest rates are a common feature of finance. This scenario can have some benefits for companies and individuals who are looking to refinance or take out loans. However, it can also be problematic for others.
- Bank account holders see less growth in their savings and money markets accounts.
- Permanent-life policyholders who pay their premiums from their policy’s accrued cash value may have to pay out of their own pocket.
- It is harder for those who depend on investments to find reliable and safe sources of income.
Fixed-income investments are especially difficult to hit as they tend to attract retirees and workers closeing retirement. These conservative investments should be able to pay for investors’ expenses and minimize or eliminate the need to dip into principal.
Fixed-income investors are now more responsible than ever to find alternative investment strategies to traditional deposits accounts and US Treasury bonds. To make the numbers work, you may need to take on more risk.These are the highest-paying jobs, in order of increasing risk.Fixed-interest InvestmentOptions in a low- or declining interest rate environment – where to go when rates are low.
Online Savings Accounts
Traditional bank savings accounts are the most basic of investments. They pay about the same annual rate and the monthly yield on Treasury bills, which is currently close to zero in some cases. Online savings accounts have a slightly higher yield. Digital banks have lower overhead than brick-and-mortar counterparts, which allows them to pay more. Make sure that the institution is FDIC insured
Certificates of Deposit
Sometimes, investors also get slightly higher rates than savings accounts.Certificates of Deposit (CDs)? The rate is the same for the entire term of the CD. It can vary from one month to five years. CDs with longer terms pay higher rates than CDs that have shorter terms. If interest rates rise, CDs’ locked-in rate can be a negative thing. If interest rates rise, bump-up CDs let investors increase the rate for the duration of the term. Sometimes this can be as much as two times. You can also withdraw funds prior to maturity without having to pay a fee with no-penalty CDOs.
These features are often at a lower yield.
Moving a portion of your fixed income funds into a CD might be smart. Another option is to ladder the CDs and buy certificates with different maturity dates. This will allow you to have more liquidity.
Corporate bonds
Fixed-income investors often turn to the bond market for a higher yield than accounts and bank products. As a class, bonds are conservative and can be used to build fixed-income portfolios. This is especially true for US Treasury bonds. Where else can you turn when Treasuries yield almost nothing?
One option is Corporate bonds. These are issued by capital-hungry companies. These bonds are more risky than US Treasury bonds, but they can be fairly safe from default as long as they are issued by companies with strong financial histories and balance sheets.
These bonds are usually rated by an independent credit rating agency like Moody’s or Fitch. These bonds are considered “investment grade” which means they are the most risky.
ETFs for High Yield Bonds
Bonds below BBB are known by many names, including “non-investment grade”, “high-yield” and, most famously, “junk bond”. These bonds have higher interest rates but are more at risk of default than investment-grade counterparts.
They are not prohibited from investors but they do carry a higher risk. You can be sure of maximum safety by investing through a bond exchange traded fund (ETF), which has a diverse portfolio of these instruments that have been carefully selected by professional money managers.
Municipal Bonds
Municipal bonds, also known as munis or municipal bonds, are issued by states, cities and counties to fund public infrastructure and construction projects. These bonds offer higher yields than bank deposits and tax advantages. For investors who reside in the state that issues them, they are exempted from federal income taxes and state and local taxes.Munis’ stated rate of interest is lower than corporate bonds’, because it is tax-free. When you add in the tax that you would owe on the corporate bonds, the interest rates of both are often equal. The muni is more beneficial if your tax bracket is higher.
Munis come with letter ratings, just like corporate bonds. General obligation bonds (GO) are the safest. These bonds are backed by the issuing government entity and not revenue from specific projects.
Funds for defined maturity bonds
Investors can invest in individual bonds directly and keep them until maturity. However, this can be costly and time-consuming. ETFs, which are defined-maturity bond exchange traded funds (ETFs), allow investors to invest in thousands of bonds all in one fund. Each fund has a maturity which determines when it closes and when net assets are distributed. In essence, defined maturity bond ETFs combine the best aspects of individual bonds and bond funds. The yields of bond fund ETFs vary depending on the type of bonds in the fund (corporate or muni), as well as the maturity of each fund, which can be between one and 10 years. Bond yields drop as interest rates rise and selling bonds when rates rise will result in losses. Bond managers constantly buy and sell bonds to maintain the fund’s average maturity over time.
The financial takeaway
Although it can be difficult to find good returns at low interest rates, there are viable fixed-income investments that offer high returns. There are many options for saving online, including CDs and bonds.
As a class, bonds are conservative and can be used to build fixed-income portfolios. Debt securities, whether individual bonds or bond funds offer higher yields than other fixed-income vehicles like CDs and bank accounts. The return on investment is always greater than the risk. This is the most important rule for investing in any environment. Fixed-income investors should be open to lowering their risk tolerance when interest rates are low. At the very least, until interest rate rises again.