With interest rates expected to keep climbing, now is the most opportune time to review your options for your cash and investment accounts to make sure they are positioned appropriately for both your short term and long term goals.
Perhaps you've been keeping your short-term assets liquid because rates were too low to justify doing anything else. But now you're wondering if it might be time to get back into money markets and certificates of deposit. Or maybe you want to invest some of your reserves in higher-yield products, only you aren't sure which products to choose and how to time those purchases.
The temptation to react to market twists and turns is understandable. But rushing to change your investment strategy without first consulting a financial advisor could be a mistake, cautioned David Terrell, sales manager with City National Securities.
It is better to come up with an overarching plan for your portfolio that serves your long-term financial and retirement goals, Terrell said. The idea is to make investment adjustments within that framework - and with your advisor's input. This applies whether you're 30 and planning to work several more decades, or you're just a few years away from retiring.
“That makes all of these decisions much more focused and less erratic, regardless of what rates and economies and markets are doing," Terrell explained.
Before you begin moving your money around, you'll need to isolate your short term and liquid money with your longer-term, investable cash. “My suggestion as to how you should view their short term needs is to think of it as emergency funds," said Mary Helmich, City National Bank's head of personal banking.
If you haven't done so already, start with a clear understanding of your total monthly living expenses. Be certain to think holistically and include expenses such as insurances and taxes. For those with a steady income, Helmich advised keeping six to nine months' living expenses in liquid bank accounts. For others, such as business owners or those with multiple and fluctuating income sources, she suggested keeping enough liquidity to cover 12 to 18 months' expenses in your reserves. Also, keep in mind that when there is disruption in income, the higher one's income level is it will typically take longer to replace that income with another source.
Once you've identified how much in liquid funds you should keep at hand, you can then update your savings and investment tactics with the guidance of your financial advisor, adjusting your strategy to leverage the potential increasing interest rates, advised Helmich.
If during the past two years you've limited your rainy day funds to checking and savings accounts, it's may be time to revisit that strategy and consider money markets and certificates of deposits (CDs).
Money market accounts and CDs are both federally insured savings accounts that earn interest, usually at a higher rate than standard savings accounts. However, CDs also tie up your savings for a designated period of time because these accounts include penalties for withdrawals before the specified maturation date.
“Money market accounts and certificates of deposit are definitely paying more than they were a couple years ago," said Erich Klein, head of sales for City National Bank's personal and business banking. “So there's a chance to increase your rate of return on your liquidity."
Purchasing multiple CDs and staggering (or "laddering") their maturation dates is one method for keeping funds relatively liquid while boosting your yield, Klein said. Staggering the purchase dates of a handful of CDs also will allow you to take advantage of rising interest rates since you can move funds into higher-yield accounts as rates go up.
There are more complex products that allow investors — particularly high-net-worth individuals — to hedge their investments including floating rate investment funds and Treasury Inflation Protected Securities (TIPS). Both are products that fluctuate with market changes.
Floating rate funds allow you to invest in bonds, loans and other financial instruments that pay a variable interest rate. Because the rate is not fixed, these investments can adjust with market interest rate changes, which might be beneficial in a rising interest rate environment.
TIPS, on the other hand, pay interest at a fixed rate twice a year. However, their principal rises and falls with inflation and deflation. Upon maturation, the investor receives either the adjusted or the original principal, depending on which has a higher value.
The beauty of both types of products, Terrell said, is that “If rates are rising or inflation begins to creep up, you can still benefit from the investment purchase while hedging some of your duration risk."
There's always the chance that the market won't behave as predicted and rates will decrease. If so, some floating-rate and inflation-protected investments might be adversely affected.
Be sure to work with your financial planner on whether purchasing such investments adheres to your financial goals.
When it comes to choosing investments with the help of your financial advisor, the duration of the investment is just as important as yield. “You have to be cautious in this environment of rising rates," Terrell said. “Otherwise, you could get stuck owning a CD, bond or other investment that all of a sudden is no longer competitive if rates rise."
Purchasing short- and middle-term CDs and other investments can help you avoid getting locked into any particular purchase for too long. For instance, rather than purchasing 3- or 4-year CDs, you could purchase CDs that mature after six, 12 or 18 months.
“This gives you a little bit of an insurance policy," Terrell said. “You can come up for air and evaluate the current interest rate environment as your investments mature."
As rates climb, it's understandable that you might be fretting over whether you should buy an enticing investment product now or wait. But if you've consulted with your advisor and the investment in question is in line with your long-term strategy, sometimes it's best to take the leap.
“If you have a goal-based financial plan and there is an attractive rate out there that gets you to your goal, consider taking it," Terrell said. “The planning, advice and consultative approach turn this process into more of a marathon than a bunch of sprints, which I think is healthier for the investment portfolio and your peace of mind."
Don't make such decisions in a vacuum: “Step back and have a discussion with a financial planner or someone who can give expert advice on the entirety of your situation, given the combination of rising interest rates, tax law changes and the overall strong position of the economy today," Klein said.
Securities offered through City National Securities, Inc. (member FINRA/SIPC) and a wholly owned subsidiary of City National . Deposits maintained with City National are not SIPC insured.
This article is for general information and education only. It is not to be construed as an offer, or solicitation of an offer, to buy or sell any financial instrument. It should not be relied upon as specific investment advice directed to the reader's specific investment objectives. Any financial instrument discussed in this article may not be suitable for the reader. Each reader must make his or her own investment decision, using an independent advisor if prudent, based on his or her own investment objective and financial situation. Prices and availability of financial instruments are subject to change without notice. Financial instruments denominated in a foreign currency are subject to exchange rate risk in addition to the risk of the investment. City National (and its clients or associated persons) may, at times, engage in transactions in a manner inconsistent with this article and, with respect to particular securities and financial instruments discussed, may buy from or sell to clients or others on a principal basis. Past performance is not necessarily an indication of future results.
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