The Federal Open Market Committee announced plans Wednesday to cut its bond-buying program to $65 billion a month in February, down from the current pace of $75 billion a month.
The FOMC also reaffirmed that the current federal fund rates of zero to 0.25 percent will continue as long as the U.S. unemployment rate, now at 6.7 percent, remains above 6.5 percent and the inflation rates stay below the central bank’s 2 percent target.
With uncertainty on when interest rates will rise, investing in bonds may seen tricky, but it doesn’t have to be. Follow these tips from the experts:
“Recognize that in a higher rate environment, bond funds are going to be a tough place to be, and you are going to take a principle loss,” says David Twibell, president of Denver-based Custom Portfolio Group. Last year, the average core bond fund fell 2 percent, including reinvested interest, according to the Investment Company Institute.
One of the solutions is a bond ladder suggests Twibell and Mike Niemczyk, president of Grayslake and McHenry-based MLN Retirement Planning, Inc. With short-term interest rates essentially at zero and volatility rising in long-term rates, go out and buy individual bonds with maturity dates spaced out over a number of years, such as two, four, six and eight years. Once your two-year bond matures, you reinvest that money in the eight-year bond. This reduces interest-rate risk.
“Because we don’t know when rates will begin to take off or how rapidly, investors should stick to short-term fixed income investments, just to be safe,” says John Gerard Lewis, manager of the Stable High Yield Portfolio at Covestor.com.
The Fed reiterated it doesn’t plan to raise short-term rates in the near future—not until the unemployment rate is lower and the central bank’s inflationary targets are met. Buying bonds with a one- or two-year duration is a conservative investment tactic and one that can mitigate any interest-rate risk.
Prudent fixed-income investors should look to bank CDs, or certificates of deposit issued by individual banks, as well, suggests Lewis. A CD is similar to a savings account and essentially risk-free. CDs have a specific fixed-interest rate and maturity date, where the CD is to be held until maturity and then withdrawn with the accumulated interest.
Lewis does not recommend local bank CDs, where the national average is 0.23 percent, but CDs at certain online banks like GE Capital Retail Bank or Ally Bank. These banks offer an FDIC-insured return of 1 percent and “unlike short-term bond funds, you’re guaranteed the return of your money and you know when you’re going to get it,” says Lewis.