Yields on Treasurys, corporate bonds and certificates of deposit (CDs) are higher than where they were a year ago and much higher than they were a few years back.
As a result, one of the most common questions I’m asked is whether investors should lock in these rates for the long term.
I don’t think that’s the right move.
Short-term rates are higher than long-term rates across many kinds of fixed income investments right now, which is the opposite of how things usually are.
You can get 5.39% on a 4-week Treasury and 5.4% on an 8-week Treasury, which is the highest-yielding Treasury. But if you go out to one year, you’ll earn 4.67%. Beyond that, the 5-year Treasury yields 3.89% and the 10-year yields 4.01%. (Keep in mind that all of these rates are annualized.)
The best six-month CD rate is 5.5%. If you lock your money up for a year, you’ll still earn 5.5%. But if you do so for three years, you’ll earn 4.75%, and for a five-year CD, that drops to 4.6%.
In corporate bonds, you can earn about 6% on a BBB rated bond for one year and 7% on a bond with a three- or five-year maturity, but that goes down to 6.48% for a 10-year maturity.
Personally, I would never lock up my money for several years to earn less than 5%.
Now, with respect to interest rates, nearly everyone believes they are going to be much lower by the end of this year.
But even if I’m wrong and rates do fall, they won’t stay low forever. Look at how drastically rates have climbed recently. Only three years ago, the 10-year Treasury yielded just over 1%.
Many investors have anchoring bias. They rely too heavily on previous information even if that information is not accurate or no longer relevant.
For example, retailers take advantage of anchoring bias all the time by offering similar products at different prices, which pushes you to buy the cheaper product – even if it’s not a great deal.
You may be at a ballgame where a large beer costs $18 but a regular beer is $14. That $14 Michelob doesn’t sound so bad now, does it?
Or when you’re looking at a $60 stock and it drops to $55, you may think it’s a steal… even though some fundamental research would suggest that it is still too expensive.
The low rate world that we lived in for several years has made today’s rates seem juicy. But historically, they are not high at all.
Going back to 1962, the average yield on the 10-year Treasury is 5.87% – quite a bit higher than where it is today.
The same is true for inflation. We got used to near-zero inflation for years, so today’s 3.35% still seems high. But the long-term average inflation rate is 3.28% – right about where we are today.
I believe fixed income should be an important part of everyone’s portfolio because it can provide ballast when stocks tumble and it can generate safe income. But unless interest rates really take off and get to very high levels, I do not recommend locking your money up in bonds with maturities longer than a few years – and certainly not in any long-term bond mutual funds that are guaranteed to lose money if rates rise.
I have a lot of my cash in Treasurys and CDs that mature in one year or less. Those vehicles are great places to keep your short-term cash.
Sure, if rates drop, you could miss out on some extra interest for a few years by not investing in longer-term bonds.
But even if rates do fall, I expect it to be part of a normal cycle in which rates and fixed income yields are constantly fluctuating. I don’t suspect we’re going back to a zero interest rate or even low rate environment anytime soon.