This article was published in the New Haven Register on March 26, 2021.
The interest you earn on CDs and bonds are still near a low point again, after briefly rising in2015-18 from historic lows after the 2008 financial crisis.
When yields are low, many people buy CDs or bonds with five-year maturity periods, becausethey earn more interest than those with briefer maturities. What happens, though, if interestrates rise? Those buyers have locked in a lower rate for five years and cannot take advantageof higher rates.
One strategy is called laddering. It’s a strategy that may allow investors to respond morequickly to changes in interest rates, and it may help produce a steadier flow of income forretirees.
Laddering means that you buy multiple CDs or bonds, each with a different date of maturity.You can buy CDs, for instance, that mature in in one, two, three, four and five years. Here’san example: Start by purchasing five CDs, each with a different maturity date. Then, as eachCD matures, you reinvest the money into new five-year CDs. After five years you will havefive long-term CDs, each earning higher interest rates than those with shorter terms, but withone maturing every year instead of all maturing at the same time.
This strategy may help smooth out returns whether interest rates rise or fall. If rates fall, youwill still obtain a lower yield when you reinvest, but you will also hold the long-term CDs withhigher returns. If rates rise, then you will reinvest each year at higher yields rather thanhaving all long-term CDs that are locked into the lower rates.
Bonds can give you even more flexibility in terms of maturity periods and types ofinvestments. You can buy corporate bonds or tax-free municipal bonds, for example. Thehigher the interest, the higher the risk. Laddering gives you a way to diversify by having someof each, again with different maturity periods.
The number of bonds offered in the market is staggering. An experienced financial plannercan help you decide, based on your individual needs and tax bracket, whether to invest inbonds and whether tax free bonds or taxable bonds make the most sense. A financial advisercan also help you determine how many steps you need on your ladder and how high yourladder should go (i.e., the longest maturity).
Both bonds and CDs can play an important part in diversifying investment portfolios andproviding a stream of income to retirees.
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