Updated: May 3, 2013 12:14PM
Originally published: November 11, 2004
There’s no doubt about it. The Fed is serious about raising interest rates. And even if the Fed decides to halt its increases after Wednesday’s boost, the rest of the world will demand higher rates to compensate them for holding dollars that are losing value daily.
For borrowers, this means it’s time to seriously consider the impact of rising rates on your mortgage, home-equity loan and credit-card payments. If you can lock in rates or pay down debt, this is the time to do it.
For savers, the probability of continually rising interest rates brings some issues. If you have money in CDs or money market funds, should you lock in rates today or wait until they’re even higher? And how high is high in this cycle?
You know you’ll kick yourself if the economy softens next year, and rates retreat, so you’re tempted to lock in higher rates now. But maybe you should wait for rates to move higher. Then again, you don’t want to stick with money market funds at today’s low yields, when CD rates are rising.
How to ladder
There’s a solution. It’s called “laddering.” And now there are mutual funds to help you do it.
This is a concept where a picture is worth a thousand words. So, picture that you have some money in your money market fund, currently earning 1.25 percent. You notice 6-month CDs at some banks are paying 1.6 percent, and one year CDs could bring a rate of 2.4 percent, according to Bankrate.com.
Now you’re faced with a dilemma. Do you move all your money into CDs to capture the current higher rates? Or do you wait? Or do you move part of your money this month, more next month, and more the following month?
If you take the last alternative -- dividing up your money and moving it one portion at a time -- you’re “laddering” your portfolio. You’re staggering the maturities of your investments, and as each CD matures, you’ll be able to re-invest at then-current rates.
If rates continue to rise, the money you put into CD’s next month will earn a higher rate than the money you locked up this week. But the first CDs will mature, and maybe capture even higher rates in three months. Instruct the bank to keep re-investing the maturing CDs at whatever rates are in effect at the time.
It’s easy to manage your money in this fashion -- if you have nothing better to do with your time. But now there are two mutual funds that will ladder your portfolio for you at a very low cost. In fact, they use slightly more sophisticated, but still short-term investments that make up in yield for the cost of their fees.
The funds come from Thornburg Investment Management, www.Thornburg.com, and can be purchased through mutual fund supermarkets like Schwab and Fidelity without paying a load or commission. Minimum investment is $5,000. You can call them at (800) 847-0200 for more information.
The Thornburg Limited Term Income fund is currently yielding 3.78 percent, and it invests in short-term, top-quality government and corporate bonds, averaging an AA rating. The current yield is tempting, but the total return for a year is just 2.2 percent, reflecting the fact that as rates rise, the market value of even these short-term bonds falls.
But when the low-yielding bonds mature, the proceeds will be reinvested in higher-yielding securities, if rates are higher at the time.
For investors seeking tax-free income on a laddering basis, Thornburg also offers a Limited Term Municipal fund, currently yielding 3.05 percent, with an average maturity of 3.8 years, and average AA rating on its investments.
That 3.05 yield is tax free, and if you’re in the 35 percent bracket, the yield is equivalent to 4.69 percent on a taxable basis.
When you ladder your investments, you’ll never get the highest rate for all your money. But your yield will always move with the trend, and you’ll never kick yourself for locking up all your money at the wrong time.
That’s the way to play the interest rate game without remorse. And that’s The Savage Truth.
Terry Savage is a registered investment adviser. Distributed by Creators Syndicate.