It seems like it’s been forever since we’ve seen decent yields for savers, but that finally could be changing.
With the U.S. economy going full steam ahead, by midyear the Federal Reserve may raise interest rates for the first time since 2006, according to recent remarks by Atlanta Fed President Dennis Lockhart.
It can take a while for certificate of deposit rates to catch up once that happens, but financial planners say there are a few things investors in CDs or share certificates, the credit union industry’s counterpart to CDs, can do now to capitalize once those rates rise.
“The biggest thing is, it pays to do a little research and ask questions,” says Cary Guffey, a certified financial planner and CFP Board ambassador based in Birmingham, Alabama.
CDs and share certificates are considered the safest investment vehicles for savers because they’re insured, respectively, by the Federal Deposit Insurance Corp. and the National Credit Union Administration.
Bump-up certificates
If interest rates rise, a bump-up CD or share certificate allows the owner to request a corresponding rate increase. Bump-up certificates are great for investors worried about chasing yield in low-rate environments like today’s. The disadvantage is they typically have lower interest rates than fixed-rate certificates, and many carry higher minimum-deposit requirements.
Of course, there’s no guarantee interest rates will go up.
“If the interest rate does not increase during the term of the CD, then you have the lower rate for the duration,” says Andy Tilp, a CFP and the president of Trillium Valley Financial Planning in Sherwood, Oregon. “The pundits have been predicting increased interest rates for many years, only to be surprised when it doesn’t happen.”
Step-up certificates
Step-up CDs or share certificates are similar to bump ups, but interest rates are automatically increased at specific intervals. Under a 28-month CD, for example, you may start with a low interest rate. But the rate would automatically go up at seven, 14 and 21 months. Step-up certificates can be a low-stress way to ride interest rate trends and help you avoid early-withdrawal penalties. But again, initial interest rates are typically low, and some of these CDs and share certificates are callable, meaning you may never see the step up because the issuer may redeem them before they mature.
‘Laddering’
Another way to prepare for higher interest rates is to “ladder” your investments. For example, say you have $15,000 you want to invest. You could divide the $15,000 into five $3,000 CDs, each with a different maturity date. Each CD makes up one rung of the ladder.
That way, every year after the initial purchase, a CD or share certificate will mature. You’ve got cash available at frequent intervals that can be reinvested if or when interest rates rise.
The disadvantage? Your rate of return may not keep up with inflation, which can erode the purchasing power of your investments over time, Tilp says.
The ‘barbell’
Some advisors argue that ladders don’t work as well as certificate “barbells” right now.
With a barbell strategy, half your money is put into certificates with short-term maturities and the other half in those with long-term maturities.
“What happens is if you’re wrong and interest rates don’t move … at least half of your money is productive while the other half is still waiting,” Guffey says. “If you’re right and rates do go up, you have that money that’s liquid to better capture interest rates.”
Nonstandard time frames
Scared of the rising-rate game? Ask your bank or credit union if it has any specials – certificates available in nonstandard time frames, such as 13 or 15 months (compared with six or 12), that typically carry slightly higher interest rates.
Interest rates have long been near historic lows, but it’s only a matter of time before they rise again. Following these tips can help you position your savings portfolio for what may come.
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