Investment Ideas for the Peak Rates Era

April 12, 2024
With the Fed projecting rate cuts later this year, you may be wondering what moves to consider today.

In addition to tamping down inflation, the Federal Reserve's historically aggressive rate-hiking campaign of the past two years also helped boost returns from relatively lower-risk cash investments and other interest-paying assets to levels not seen in years.  

But peak rates can't last forever. With the Fed now projecting a cumulative 75 basis points worth of rate cuts this year, investors may be wondering if they should grab as many cash investments as possible before returns start to fall.

For your reference, here are where some common shorter-term yields stood recently. Note there are some pretty wide variations between average yields and top yields for certain investments, suggesting not all banks offer attractive yields. As always, it can make sense to shop around:

Short-term interest rates

Yield-bearing checking account: National Avg: 0.1%, Top 1% Avg: 3.4%; Yield-bearing savings account: National Avg: 0.5%, Top 1% Avg: 5.0%; Money market fund: National Avg: 0.7%, Top 1% Avg: 4.8%; CDs (<1 yr maturity): National Avg: Up to 1.5%, Top Rate: Up to 5.5%; Treasury bills (<1 yr maturity): 5.2% to 5.4%; CDs (1-4 yrs maturity): National Avg: Up to 1.8%, Top Rate: Up to 5.8%; Treasury notes and bonds (1-4 yrs): 4.3%-5.1%; Munis (1-4 yrs): 3.4%-3.9%; Corporate bonds (>BBB, 1-4 yrs): 4.4%-5.3%

Sources: (1) National deposit rate from FDIC as of 3/18/2024. (2) LendingTree through DepositAccount.com on 3/26/2024. The Top 1% Average refers to the average rate available from highest-yielding accounts. (3) Schwab BondSource® on 3/26/2024. ​In the bond market, there is no centralized exchange or quotation service for most fixed income securities. Prices in the secondary market generally reflect activity by market participants or dealers linked to various trading systems. Bonds shown in or offered through Schwab BondSource® may be available through other dealers at superior or inferior prices compared to those shown on Schwab BondSource®. Schwab BondSource® is a proprietary fixed income quote and order management system. Mark ups and transaction fees may be applied that could impact yields.  All prices/yields are subject to change without notice. For illustrative purposes only. Past performance is no guarantee of future results.

So, what kind of moves should one consider now? We've gathered a few ideas here that could make sense in the twilight of the rate cycle.

Cash and cash investments

When it comes to cash and cash investments, it's generally not a simple matter of "when rates are high, invest in X." Rather, Schwab prefers to focus first on how you're planning to use the funds, and then deciding the most appropriate way to invest them. So:

  • Cash for immediate needs and emergencies. A checking account can help cover daily spending needs, check-writing, and ATM usage. Bank checking accounts are insured by the Federal Deposit Insurance Corporation (FDIC), an independent agency of the US government, against the loss of up to $250,000 per depositor, per insured bank, based on account ownership type. In addition, we generally recommend investors maintain an emergency fund holding three to six months of essential expenses (though, retirees have special needs, which we'll discuss below). Because you may need to access such funds quickly, consider keeping them in a yield-bearing savings account. Returns may be lower than you might find with other assets, but liquidity is key. 
  • Cash you may need soon, but not urgently. If you're willing to wait a day to access your cash,1 you could consider a purchased money fund, which is designed to keep your money relatively safe and can offer a higher yield than a savings account. Such funds invest primarily in high-quality, short-term debt securities. Although yields fluctuate, money funds strive to preserve the value of your investment. That said, these funds aren't FDIC-insured, but investment assets in your brokerage account are typically protected up to $500,000 per investor by the Securities Investor Protection Corporation (SIPC), in the event a SIPC-member brokerage fails.
  • Cash you'll need in the coming years. For goals that you want to accomplish within the next two to four years—say, saving for a down payment on a home, buying a car, or taking a big trip—consider a Certificate of Deposit (CD). You can get one either from  a traditional bank or a brokered CD from a brokerage account. Both types offer a fixed rate of return in exchange for locking away your funds for a set period of time, generally between three months and five years. As a rule,  CD yields are higher the longer your money is invested and are typically (but not always) higher than yields on individual U.S. Treasury bonds or purchased money funds. You can withdraw from a CD before maturity, but you might face some tradeoffs. With a bank CD, you may be charged an early withdrawal penalty and receive back less than the premium at maturity. With a brokered CD, there's no early withdrawal penalty, but you would be subject to potential trading fees as well as current market rates, which could increase or decrease the value of the CD. Both types of CD are typically insured by the FDIC against the loss of your money up to $250,000 per depositor, per FDIC-insured bank, per ownership category.
  • Cash in your brokerage account. Uninvested cash from this type of account may earn interest and is available for investing or managing expenses. Holding cash here is appropriate if you plan to spend the money within a few days or would like to quickly place a trade. Cash in your brokerage account is typically protected up to $250,000 by the SIPC.

Special considerations for retirees

Because retired investors must draw an income from their savings, we recommend they consider structuring their funds with both liquidity and longer-term growth in mind. That means:

1. Setting aside one year of cash and cash investments

Try to set aside enough cash—minus any regular income from rental properties, annuities, pensions, Social Security, investment income, etc.—to cover a year's worth of retirement expenses. As with cash that you might need for any immediate or upcoming goal, you could consider using a relatively safe, liquid account, such as an interest-bearing bank account, money market fund or short-term CD.

With such holdings, you won't have to worry as much about the markets or a monthly paycheck. Spend from this account and replenish it periodically with funds from your invested portfolio. Then invest the rest of your portfolio sensibly.

2. Creating a short-term reserve

Within your main portfolio, starting with accounts that you may need to tap soon, create a short-term reserve to cover withdrawals from your portfolio and help weather a prolonged market downturn—we recommend two to four years' worth of living expenses, again after accounting for other regular income sources, if you can. This short-term reserve will help prevent you from having to sell more volatile investments, like stocks, in a down market.

This money can be invested in high-quality, fixed income investments, such as short-term bonds or bond funds. Or, if you'd rather manage individual investments, you might want to create a short-term CD or bond ladder--a strategy in which you invest in CDs or bonds with staggered maturity dates so that the proceeds can be collected at regular intervals. When the CDs or bonds mature, you can use the money to replenish your bank account. 

With a year's worth of cash on hand and a short-term reserve in place, consider investing the remainder of your portfolio in investments that align with your goals and risk tolerance. 

When you're deciding where to hold your cash, ease of access, insurance, and yield all figure into the picture. For near-term use, accessibility will be a big consideration, while cash for long-term use has the potential to earn higher returns. No matter how you deploy your cash, be sure to revisit your decisions as your plans, goals, and needs change.

Don't overlook longer-term bonds

Why lock your money up in a longer-term bond when when you can earn higher yields from short-term investments like Treasury bills, short-term CDs, or money market funds? 

When the Fed starts cutting rates, the prices of existing bonds (and bond funds) tend to rise, while yields fall. As a result, if you wanted to reinvest the proceeds from maturing bonds in more short-term securities, you might end up doing so at lower yields—a problem known as reinvestment risk. 

Shifting into intermediate- and longer-term bonds, on the other hand, could allow you to lock in higher yields for longer. Plus, you could see a price bump.  

A quick look at short-term total returns supports the case for investing in longer-term bonds once the federal funds rate hits its peak. Over the last four rate hike cycles, intermediate-term bonds outperformed short-term bonds in the 12 months following the last Fed hike of each cycle.

We compared the total returns of the 1-3 year subset of the Bloomberg U.S. Aggregate Index (short-term bonds) to those of the 5-7 and 7-10 year subsets. In each of the four previous rate-hike cycles, the intermediate-term indexes outperformed the short-term index, and often by a wide margin.

Total returns months after the federal funds rate hit its peak

Series of bar charts showing the 12-month total return following the peak federal funds rate for the Bloomberg US Aggregate 1-3 year bond index, 5-7 year bond index and 7-10 year bond index. In the four past peak-rate periods, both the 5-7 year and 7-10 year bond indexes outperformed the 1-3 year index.

Source: Bloomberg.

Source: Bloomberg. Twelve-month total returns for each period are as of month-end. Total return includes interest, capital gains, dividends, and distributions realized over a period. Past performance is no guarantee of future results. Indexes are unmanaged, do not incur management fees, costs, and expenses and cannot be invested in directly

Total return includes interest payments and price changes. It is different from yield, and when you invest in a bond and hold it to maturity, your average annualized return will be pretty close to the starting yield of that bond. But in the short run, the price of bonds (or bond funds) can fluctuate depending on market conditions, as bond prices and yields generally move in opposite directions. The magnitude of those fluctuations depends in part on the bonds' time to maturity. Short-term bond prices are generally less sensitive to interest rate changes than bonds with longer maturities.

Total returns might not matter as much for investors holding a portfolio of bonds to maturity (or those who hold bond funds for longer periods of time). But these returns can still provide more of a boost to a portfolio compared to a portfolio that holds just short-term bonds. 

Consider income annuities

Bonds and cash investments aren't the only assets offering potentially higher income these days. Income annuities—insurance products offering guaranteed income—are also offering higher payouts than they have in years

How much higher? We looked at 21 years of data and found single premium immediate annuity (SPIA) payout rates, like the average Moody's Aaa corporate bond yield, are now at their highest levels in over a decade. 

Moving up

Chart comparing payout rates for a SPIA offering lifetime income with a 10-year certain payout feature with the Moody’s Aaaa corporate bond yield. SPIA payout rates for both men and women are around 7%, while the Moody’s yield is around 5%.

Source: Schwab Center for Financial Research. For illustrative purposes only. Past performance is no guarantee of future results.  Payout rates are life payments for single male and female annuitants, with a guaranteed 10 years of payouts whether the annuitant lives or dies during that period. (As of September 2023). The payout rates shown represent average payout rates from a representative selection of income annuities today. Historical annuity annual payout rates are from immediateannuities.com's Comparative Annuity Reports and Annuity Shopper Buyer’s Guide.

The Moody's Aaa Corp. Bond Yield was taken from the St. Louis Federal Reserve

As a reminder, annuities are fairly unique investments. Income annuities are contracts between you and an insurance company. In exchange for a portion of your savings, an insurance company will guarantee a stream of income. That income can either be for a certain period of time or it can be for a lifetime (assuming the insurer remains in good financial health). It can start immediately (within 12 months) or deferred to a later date (beyond 12 months). Costs for income annuities are typically built into the contracted payout rate and can vary based on the insurance carrier, so it pays to shop around. 

Keep in mind, too, that these contracts are irrevocable. Once you pay the premium, you get a brief "free look period" ranging from 10 days to a month during which you can change your mind and ask for your cash back. After that, you're locked into the contract. 

So, whether an annuity is a "good" investment depends not only on how long you live but also what you value. One investor might prefer the certainty that comes from a guaranteed income they can't outlive, even if it means giving up control of a chunk of their savings. Another might think it better to keep ahold of their savings and leave them invested in the market, potentially for bigger returns or a bigger legacy for their family. Both approaches can work and, for some investors, combining both approaches may work even better.

Based on our research, you could consider starting with between 10% and 25% of your savings for an income annuity, but not more than 50%. Consider keeping the rest invested to suit your spending needs and offer growth potential.

It may be best to work with a financial professional to help think through the pros and cons, the costs, and the different benefit options available with an income annuity. 

In sum

Today's higher interest rates give investors a variety of options for making strategic use of the cash in their portfolios. If you aren't already making the most of your cash holdings, consider doing so soon. 

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