Wealth InFormation: Reinvestment Risk
Wealth is always in formation, whether one chooses to actively manage their formation or let finances play out as they may without the proper information.
A common conversation I am having with clients right now revolves around interest rates. Higher rates have been a sore spot for borrowers but have been a blessing for savers! Many people have enjoyed the last year and a half or so of higher earnings on conservative investments such as Certificates of Deposit and Money Markets. While they have been safegaurded from market risk, they have not considered another risk: reinvestment.
Rates on money markets change frequently, following the direction of overall interest rates. Therefore, as the federal reserve prepares to lower rates, expect money markets to follow suit. CD’s guarantee rates for a period of time, such as a year or two. What will your options be when that CD comes due? You face the risk of having to reinvest in a newly issued CD that may be at a significantly lower rate than the one you just matured out of.
Options to consider that may mitigate investment risk include municipal and corporate bonds, and fixed annuities. There are many attributes to consider when investing in bonds, including it’s yield and duration. Yield is the income that the bond will provide. Duration is the bond’s price sensitivity to movements in interest rates, as there is an inverse correlation between the direction of interest rates and the value of bonds. When interest rates rise, the value of bonds tends to fall. Conversely, when interest rates fall, the value of bonds tends to rise. It may be prudent to consider bonds with an intermediate duration which may allow an investor to take advantage of current yields for a more durable length of time than could otherwise be provided by an investment that matures in a year or two.
Fixed annuities differ from issuer to issuer, so it is important to know all aspects of a fixed annuity that you may be considering. We have helped our clients find fixed annuities that do not have fees, that guarantee a rate of return for five or seven years and have a guarantee of principal safety by the issuing company. Investing in a fixed annuity can extend the guaranteed rate of return for a longer period of time than many CDs may offer, with the added benefit of tax deferral. Annuities of any type are most suitable for more mature clients, as withdrawals prior to age 59 ½ would impose a tax penalty.
Wealth is always in formation and with the proper information, you may avoid risks to your principal, as well as reinvestment risk.
LouAnn Schulfer of Schulfer & Associates, LLC Wealth Management can be reached at (715) 343-9600 or louann.schulfer@lpl.com TheWealthInformationLady.com SchulferAndAssociates.com , or louann.biz
Securities and advisory services offered through LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All investing involves risk including loss of principal. No strategy assures success or protects against loss.
CDs are FDIC insured to specific limits and offer a fixed rate of return if held to maturity, whereas investing in securities is subject to market risk including loss of principal.
The market value of corporate bonds will fluctuate, and if the bond is sold prior to maturity, the investor’s yield may differ from the advertised yield.
Municipal bonds are subject to availability and change in price. They are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free but other state and local taxes may apply. If sold prior to maturity, capital gains tax could apply.
Fixed annuities are long-term investment vehicles designed for retirement purposes. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply.
