How To Invest In A High Interest Rate Environment

financial planning for attorneys financial planning for entrepreneurs financial planning for retirement financial planning for young professionals Nov 06, 2023

The Fed is currently holding interest rates steady, with the Fed Funds rate range between 5.25%-5.5%.

Because of high interest rates, cash is hot. We haven’t seen interest rates on cash/cash equivalents this high since before the Great Financial Crisis. The Fed has also indicated that higher rates may remain elevated for longer. When the Fed is expected to cut rates is unknown, but at present the market expects the first rate cut of 0.25% to not occur until the summer of 2024 at the earliest. We would not be surprised if the Fed takes a wait-and-see approach for the entirety of 2024, with little change in rates.

The economy as a whole remains very strong. In October 2023 we saw real GDP (gross domestic product) in the U.S. grow at a whopping 4.9% annual rate! Depending on whom you ask, over the last year our economy has expanded at double or even triple the expected rate. The labor market remains tight, with unemployment remaining historically low at 3.8%. At the same time, the rate of inflation increase has softened since it peaked in February of 2022. As of September 2023, the Fed’s preferred inflation measure, Core PCE (Core Personal Consumption Expenditure) stands at 3.68%. These data points are encouraging.

What can you do with this information as an investor? At first blush, going into higher yielding cash might feel like the best option. With headline news consistently feeding us daily doses of fear, why would one invest money in the broader market in such a time as this?  

The answer is straightforward.

Tell me how soon you need the money and I’ll tell you how to best allocate capital. You must use history as your guide, not fear. Historically-speaking, where are you better off investing your money? Here are four scenarios. Which one best describes your circumstance?

  • If your time frame is two years or less, keep the money in cash. Specifically, look at high yield savings accounts, money market accounts, money market mutual funds, very short duration bonds, or CDs. Your primary aim here is liquidity while earning a healthy interest rate. If you’re not earning at least 4% on your cash today you are missing the boat.
  • If your time frame is 2-5 years, lock in today’s rates! Immediate liquidity is less important for this money. When rates go down (and they will go down) the rates on your high yield savings accounts, money markets, and money market mutual funds will also decrease. You can lock in today’s higher rates by buying short-to-mid duration bonds, guaranteed fixed annuities, or CDs.
  •  If your time frame is 5-10 years, consider a balanced portfolio of both stocks and bonds. You’re introducing some risk for the opportunity of more return. This could be a mix of 60% stocks and 40% bonds, or vice versa depending on your time horizon and risk tolerance. Here is a helpful chart from Vanguard on what a balanced portfolio could look like: Vanguard resources 
  • If you do not plan on touching the money for 10+ years, history clearly shows us that investment performance over the long term is far superior in a portfolio primarily composed of stocks. In fact, when comparing a portfolio of 100% bonds (fixed income) with 100% stocks (equities of the S&P 500), your return is nearly double. The tradeoff is stocks are more volatile in the short term. You’ve got to ride the waves to realize a significant return.

Don't feel like you have to select only one of these scenarios for your money. They're all great options. For example, for the funds you need in the short term invest it in cash/cash equivalents. For money you do not expect to touch for the long term, take more risk for the opportunity of more return on those funds. Many of our clients have spread their investments around in different buckets, and are allocated across multiple asset classes. 

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