Have you heard? You can purchase 6-to-12-month CDs and U.S. Treasuries with around a 5% yield. We haven’t seen this kind of teaser rate on money for a long time. Additionally, CDs under $250,000 are insured by the FDIC, and Treasuries are backed by the full faith and credit of the U.S. Government. Many investors have already taken notice, and this year we have seen record flows of money moving from banks into Treasuries and CDs.
But as the saying goes, “If it looks too good to be true, it probably is.” Although these short-term teaser rates might entice you today, they won’t last forever, and without proper planning that considers reinvestment risk, you may be leaving long-term money on the table.
Reinvestment risk is the risk that an investor will not be able to reinvest cash flows from an investment at the same rate of return as the original investment. This risk can occur when interest rates decline, and the investor is forced to reinvest their funds at a lower rate of return. Although you can purchase a 12-month CD today with a rate of around 5%, the likelihood you will be able to reinvest at 5% in 12 months is uncertain, and as a result, you may not earn as much as you had originally anticipated.
Reinvestment risk is particularly important for long-term investors who rely on compounding returns to grow their wealth over time. If an investor is unable to reinvest their cash flows at the same rate of return as their original investment, their overall return may be lower than expected. If your investment time horizon is 10 years or greater, would you rather lock in a 5% return for one year or a 3.8% return annually for the next 10 years? Focusing on the short-term rate could significantly reduce the value of your investment portfolio over time.
Our outlook is that inflation will eventually normalize, and rates will come back down in the next 12 months. When rates peak, the outlook for other fixed income securities looks much more attractive. As shown by J.P. Morgan Asset Management below, the 12-month total return for other fixed income securities tends to outperform 6-month CD rates after a peak in 6-month CD rates.
| Source: Bankrate, Bloomberg, FactSet, Federal Reserve, J.P. Morgan Asset Management. U.S. Treasuries: Bloomberg US Treasury Index, U.S. Investment Grade: Bloomberg US Corporate Bond Index, U.S. High Yield: Bloomberg US Corporate High Yield Bond Index. The analysis references the month in which the 6-month average CD rate peaked during previous rate hiking cycles. CD rate data prior to 2013 are sourced from the Federal Reserve whereas data from 2013 to 2023 are sourced from Bankrate. CD subsequent 12-month return calculation assumes reinvestment at the prevailing 6-month rate when the initial CD matures. Guide to the Markets – U.S. Data are as of June 16, 2023. |
Before you jump for the teaser rate, ask yourself, do I want to potentially miss out on higher long-term returns for a short-term gain? Investors should be aware of reinvestment risk, as well as the more commonly thought of risks like credit and duration risk when making investment decisions. You should take steps to mitigate these risks, such as diversifying your portfolio and investing in securities with longer maturities.
At Bridgeworth, we aim to build robust portfolios to help keep our clients on the path to their goals. If you have questions or would like the input of a Bridgeworth advisor, please reach out to us.
_____________________________________________________________________________________
Bridgeworth Wealth Management is a Registered Investment Adviser.
The FDIC insures deposits only. For the purposes of FDIC insurance coverage limits, all depository assets of the accountholder at the institution that issued the CD will generally be counted toward the aggregate limit (usually $250,000) for each applicable category of account. FDIC does not insure securities, mutual funds, or similar types of investments that banks and thrift institutions may offer. FDIC insurance does not cover market losses. For details on FDIC insurance limits, see www.FDIC.gov.If you sell the CD prior to maturity, the prematurity sales price may be lower than the original purchase price. This will be particularly true if interest rates rise after the original sale. The secondary market for brokered CD’s may be limited. Brokered CD’s may include a provision that allows the depository institution to redeem the CD prior to maturity at a set price.
Securities Investors Protection Corporation (SIPC) – Securities you own, including mutual funds that are held for your account by a broker, or a bank’s brokerage subsidiary, are not insured against loss in value. The value of your investments can go up or down depending on the demand for them in the market. The Securities Investors Protection Corporation (SIPC), a non-government entity, replaces missing stocks and other securities in customer accounts held by SIPC member firm up to $500,000, including up to $250,000 in cash, if the firm fails. For more information, see www.sipc.org.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not ensure against market risk.
This content does not constitute legal, tax, accounting, financial, or investment advice. Any discussion pertaining to taxes in this communication may be part of a promotion or marketing efforts. As provided for in government regulations, advice related to federal taxes that is contained in this communication is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue code. You are encouraged to consult with competent legal, tax, accounting, financial, or investment professionals based on your specific circumstances.