The Federal Reserve has strategically signaled we may be at the end of the current interest rate increase cycle, creating a pivotal moment for investors.
In this white paper, we will explore strategies to capitalize on this changing interest rate landscape. We will discuss the potential benefits of increasing Certificate of Deposit (CD) maturities, investing in dividend stocks, municipal bonds, preferred stocks, Real Estate Investment Trusts (REITs), and Fixed Rate annuities. However, it is important to exercise caution as current money market rates are not sustainable, and history has shown that they often drop to under 0.50% within two years of an interest rate peak.
The Federal Reserve’s decision to halt the current interest rate increases marks a turning point in the financial markets. As interest rates stabilize, investors need to adjust their strategies to maximize returns and preserve capital. In this section, we will briefly explain the significance of this decision and its implications for investors.
The Fed’s Interest Rate Decision
The Federal Reserve has a crucial role in managing the U.S. economy, including setting interest rates. After a series of rate hikes over the past year raising rates 20-fold from 0.25% to 5.5%, the Fed has now signaled it has decided to pause its tightening cycle. This shift in monetary policy has far-reaching consequences for investors across various asset classes.
Strategies to Capitalize on the New Interest Rate Environment
1. Increasing Certificate of Deposit (CD) Maturities
With interest rates stabilizing, investors can benefit from extending the maturity of their Certificates of Deposit (CDs). Longer-term CDs typically offer higher yields compared to shorter-term options and short- term CDs are likely to suffer from reinvestment risk at lower rates.
- High Degree of Safety
- Lock in higher interest rates for an extended period.
- Generate a predictable stream of interest income.
- CDs are insured by the FDIC and offer a fixed rate of return.
- Brokered CDs may fluctuate in market value prior to maturity.
2. Investing in Dividend Stocks
Many dividend stocks pay an attractive current dividend rate, and concentrating on companies with a history of increasing dividends can provide both capital appreciation and a growing stream of income. As interest rates plateau, dividend-paying stocks may become more attractive.
- Attractive current returns
- Reinvestment of dividends provides multiple compounding.
- Potential for stock price appreciation.
- Increasing dividend income can hedge against inflation.
Dividends are not guaranteed and must be authorized by the Company’s Board of Directors
3. Municipal Bonds
Municipal bonds can offer attractive tax-free yields, especially when interest rates are higher than historical averages. Additionally, municipal bonds may provide tax advantages, making them a compelling option.
- Current municipal bond rates are higher on average than in the last decade.
- Potentially higher yields compared to other fixed-income options.
- Interest income from municipal bonds is typically tax-free at the federal level.
- Municipal bonds typically provide a lower yield than comparable taxable investment doe to their tax advantage.i
4. Preferred Stocks
Preferred stocks are a hybrid investment that combines characteristics of both stocks and bonds. They often provide a fixed rate high current income, making them appealing in a stable interest rate environment.
- Attractive high dividend yields.
- Priority in receiving dividends and liquidation proceeds.
- Many Preferred are selling at or below Par adding additional appeal.
- In general, there are two types of preferred securities, each share the characteristics of both stocks and bonds: equity preferred and debt securities.
- See footnote for more details.ii
5. Real Estate Investment Trusts (REITs)
REITs offer exposure to the real estate market and typically provide attractive yields. As interest rates stabilize, REITs may be trading at appealing levels, presenting an opportunity for investors. Over the last few years, there has been a major shift in commercial real estate, providing attractive opportunities for astute investors.
- Attractive current yields.
- Diversification through exposure to real estate assets.
- Real estate investments can be subject to different and greater risks than more diversified investments.
- The value of real estate, economic conditions, property taxes tax laws and interest rates app present potential risks to real estate investments.
6. Fixed Rate Annuities
Fixed Rate annuities can offer competitive interest rates, providing a stable source of income. Additionally, they often come with tax advantages that can be particularly valuable in a rising tax environment.
- Guaranteed interest rates.
- Tax-deferred growth and potential tax benefits upon withdrawal.
- Fixed rate annuities may incur surrender charges or tax penalties if you are under 59 ½.
- Fixed Rate annuities are guaranteed by the issuing insurance company and its ability to pay.
Caution: Historical Trends in Money Market Rates
While the strategies outlined above can be attractive in a stabilizing interest rate environment, it is essential to exercise caution. Historical data has shown that money market rates tend to drop significantly within two years of an interest rate peak. Current money market rates may not be sustainable, and investors should be prepared for potential decreases in yields in the coming years.
The Federal Reserve’s decision to pause interest rate increases presents a unique opportunity for investors to revisit their portfolios and optimize their strategies. By considering options such as longer- term CDs, dividend stocks, municipal bonds, preferred stocks, REITs, and Fixed Rate annuities, investors can position themselves to take advantage of the new interest rate landscape. However, it is crucial to remain vigilant and monitor changing market conditions, especially regarding money market rates, which may experience a decline in the near future. Diversifying across these asset classes can help mitigate risk while optimizing returns in the evolving financial environment. It is crucial for investors to consult with financial professionals and assess their individual risk tolerance and financial goals before implementing any of these strategies.
Any opinions are those of Victor T. Connor and not necessarily those or Raymond James. Expression of opinion are as of this date and are subject to change without notices. The information provided does not purport to be a complete description of the securities, markets, or developments referred to in this material, nor is it a recommendation. Investing involves risk and investors may incur a profit or loss regardless of strategy selected.
i Investments in municipal securities may not be appropriate for all investors, particularly those who do not benefit from the tax-free status. Please consult with a tax professional to assess the impact of holding tax free securities.
ii Equity preferred- Traditionally or equity preferred stocks are similar to common stock in that they are perpetual and never mature. Like bonds, most pay a fixed payment, however the payments are dividends rather than interest. Most preferred called at Par by the issuer.
Debt Securities, – often referred to as “baby bonds” due to their par value of $25 and the pay interest like traditional bonds. As dept, they stand ahead of equity preferrpreferemcesess in the payout hierarchy should a company default. Debt preferred may be secured, unsecured, senior, junior, or subordinated in corporate equity structure. Potential investors should examine the characteristics of each issue to determine the that the investment meets their expectations and risk tolerance. Investors should understand the capital structure for priority of payments, call provisions and know the circumstance under which the issue can stop making payments and subsequent consequences. CSP 387530 01.25.24