Making Money with Low Interest Rates

Tuesday, September 22, 2009

1105756_safe_piggy_bankInvestors are taking on the price risk of long-term bonds and bond funds to increase their income. Such moves look smart on the surface with 1-year Treasury bills yielding only 0.4% and 10-year notes, 3.4%. However, the low interest rates on short-term investments could actually provide the better return. Here’s why…

Today’s low yields are destined to increase. The slow economy and the Federal Reserve’s actions are keeping rates down. When normal conditions return, rates will rise. This could happen quickly. Faster economic growth will produce funding demands and allow the Federal Reserve to reverse its low interest rate policies.

Higher yields will drive bond prices down. For example, if the 10-year bond yield rose today from 3.4% to 4.4%, the bond price would fall about 8%, wiping out almost three years of the expected higher yield. Here is what has happened historically since 1962. (Note that the current yield is the lowest the 10-year bond has been for the past 47 years.)
10-year graph-2
So, staying in short-term securities now avoids risk of price decline and  provides ready reserves to take advantage of future opportunities. Those opportunities could be significant in the bond market because current interest rates are abnormally low.

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