The cash party may be over. 2022 saw one of the most aggressive rate hike cycles in decades. Cash equivalents (i.e., Treasury Bills (T-Bills), CDs, money markets, etc.) were benefactors of yields not seen in a very long time. Now, it is time for the other side of the coin, a rate-cutting cycle. The Federal Reserve commenced its rate-cutting cycle in late 2024, with 1.00% in total cuts by 2024’s end. As interest rates come down, cash yields are likely to follow suit. Here’s how to manage reinvestment risk as your short-term securities mature.
The Federal Reserve’s aggressive interest rate hikes helped push yields on cash and shorter-term bonds to their highest levels in more than 20 years. However, with rates generally thought to be in retreat, cash investors could see their income decline as they struggle to replace the yields on their current cash and cash equivalents.
As interest rates come down, people holding short-term bonds will likely have to reinvest the proceeds from their maturing securities into those with lower yields. So, if you shifted into short-term vehicles like Treasury bills over the past few years, you might want to start looking for opportunities to gradually increase your intermediate-term holdings as rates continue to fall.
That said, consider an example of an investment in a 10-year Treasury bond yielding close to 4.6% when T-bills with very short maturities were still yielding near 4.5% as of the end of December1.
With yields being similar, you might not opt for the longer-term bond. Yields on some intermediate-term bonds dipped this summer, making them less attractive than they were in the spring. However, the outlook for intermediate-term bonds remains positive, and some are still offering attractive yields if you’re willing to tolerate a little volatility. Investment-grade corporate bonds in the 5 to 10-year range, for example, are only slightly riskier than Treasury bonds and were yielding north of 5%.
Another option may be to build a bond ladder. With a five-year bond ladder, for example, you would have one or more bonds maturing each year over the next five years, giving you an opportunity to reinvest gradually versus all at once. That way, you can continue to capture today’s relatively high rates for as long as they last, while also hedging against their anticipated decline.
Locking in today’s higher yields offers another benefit: It makes you less reliant on stock returns. For years, the bond market offered paltry yields, causing many fixed-income investors to stray into riskier areas of the market. But now that you can get intermediate- or longer-term bonds with yields over 5%, you may not have to take on as much risk to reach your goals.
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