You’ll always want to base your investment decisions on your own needs and goals. But there may be times when you might consider adjusting your portfolio because of risks and opportunities. Now may be one of those times.
Here’s some background: In recent months, the Federal Reserve has raised short-term interest rates several times, and given its generally favorable outlook on the economy, it has indicated it may continue bumping up interest rates gradually over the next year or so. The Fed doesn’t control long-term interest rates, but these rates often follow the lead of short-term movements. However, longer-term rates haven’t yet risen as much as shorter-term ones, which means the difference between short- and long-term rates is relatively small, historically speaking.
This doesn’t mean you should make drastic changes to your portfolio. You still need to stick with the asset allocation that’s suitable for your situation, which typically involves owning a certain percentage of growth-oriented vehicles, such as stocks, and a certain percentage of fixed-income securities, such as bonds. However, if you do have space in the fixed-income part of your portfolio, you may find the higher interest rates offered by short-term bonds and certificates of deposit (CDs) to be attractive. To take advantage of this opportunity, though, you will need to have the cash available to invest.
Some people hold too much in cash, waiting for interest rates to rise, or as protection against the risk of a market decline. But holding excess cash involves its own risk – the risk of not investing. So, if you have your cash needs covered, you may want to consider investing any excess cash.
To determine if you are holding excess cash, you’ll need to review your entire cash situation. For example, do you have enough cash, or cash equivalents, to create an emergency fund of three to six months’ worth of living expenses? This fund can be vital in helping you pay for things like a major car repair or an unexpected medical bill without dipping in to your long-term investments. And, of course, you need enough liquidity to provide for your lifestyle, including your regular spending needs – your mortgage, utilities, groceries and so on. Also, you may want to set aside enough cash for a goal you want to reach in the next year or so, such as a vacation.
But if you have taken care of all these needs and you still have excess cash, you may want to consider putting this cash to work, possibly by investing in short-term fixed-income vehicles now being issued at higher interest rates.
And keep in mind that regardless of where interest rates are going, bonds and other fixed-income investments can offer some key benefits to investors. In addition to providing a source of regular income, these types of investments can help reduce the effects of volatility on your portfolio. While bonds can, and will, fluctuate in value, they typically can provide more stability to your portfolio and tend to behave differently than stocks over time.
After years of historical lows, shorter-term rates now have risen to levels that are more attractive to investors. Take the time to review your situation, perhaps with the help of a financial professional, to determine if taking advantage of these rates may be appropriate for you.