Written by: Yogesh Prasad, CFA, CAIA
Why change your savings startegy?
If you have been playing it safe with your savings over the past couple of years, you have your money in something like Treasury Bills (T-bills). And for good reason—they have been offering decent returns with minimal risk. However, things are changing. The Federal Reserve is talking about lowering interest rates, and that could affect how much your T-bills are earning.
So, what should you do now? Let us walk through some smarter alternatives to ensure your hard-earned savings continue working for you in a changing financial landscape.
What are treasury bills and why are they so popular?
Treasury bills (T-bills) are short-term loans to the U.S. government. They mature quickly, typically within 3, 6, or 12 months, and they have been a favorite for anyone looking for a safe place to park their cash. The U.S. government is not likely to default, so T-bills are about as secure as it gets.
Lately, T-bills have offered attractive interest rates, thanks to the Fed’s higher rate environment. But as interest rates are expected to fall soon, those returns could shrink, leaving you with less income from your savings.
What happens when interest rates drop?
Let us break it down. If the Fed lowers interest rates, the returns on new T-bills will be lower.
For example:
- Right now, if you invest $10,000 in T-bills at 5%, you’re earning $500 per year.
- But if the Fed cuts rates and T-bills are only earning 3.5%, that same $10,000 would bring in just $350 per year.
That is a noticeable difference! So, it might be time to explore other options that could offer better returns while keeping your money safe.
Exploring other investment options: Ultra-short bonds
One alternative to T-bills is an “ultra-short” bond strategy. This involves investing in bonds that mature in up to three years, blending government bonds with highly rated corporate bonds (loans to strong companies).
- Why consider this? Ultra-short bonds tend to offer slightly higher returns than T-bills but still carry only modest risk.
- The catch? While these investments can be a bit more volatile than T-bills, the potential upside in earnings could make it worth your while.
For example:
If you shift your $10,000 from T-bills (earning 3.5%) to an ultra-short strategy that offers 4.5%, you could earn $450 per year instead of $350. It is not a huge leap, but every dollar counts when planning for your future.
Match your savings strategy to your goals
Before switching investments, it is essential to think about when you will need access to your money. Here is a simple rule of thumb to help you decide:
- Money you need within 6 months: Stick to T-bills or a high-yield savings account.
- Money you will need in 6–12 months: Consider conservative ultra-short strategies.
- Money you will not need for a year or more: Investigate ultra-short or short-term bond strategies for better growth potential.
This way, you keep your short-term cash safe while giving your longer-term savings room to grow.
How taxes play a role in your decision
Here is something many people overlook—taxes can have a significant impact on your investment returns.
- If you are in a high tax bracket, you might want to look at municipal bonds. These are loans to state and local governments, and they come with a nice reward: the interest earned is often tax-free.
- If you are in a lower tax bracket, regular bonds (like corporate bonds) might be a better fit since the tax-free benefit of municipal bonds will not make as much of a difference.
A financial advisor can help you navigate which option best suits your tax situation.
Why corporate bonds might make sense
If you are looking for a bit more income potential, consider adding some high-quality corporate bonds to the mix. These bonds are loans to large, stable companies that typically pay more interest than government bonds.
This does not mean they are risk-free, but sticking to bonds from strong, well-established companies can help you balance the desire for higher returns with the need for safety.
Protecting your savings with bonds during market volatility
A smart bond strategy can also help protect your overall savings, especially if you have some money invested in the stock market. Bonds tend to perform better when stocks struggle, meaning they can help reduce your risk when the economy hits a rough patch.
For example:
Let us say the stock market drops by 10%. If you hold a mix of bonds in your portfolio, they might rise by 3-4%, softening the blow from your stock investments.For e
Steps to take now: Your action plan
Not sure where to start? Here is a simple step-by-step plan:
- Assess Your Needs:
Look at your budget and determine how much cash you will need in the next year or two. Keep this money in safe investments like T-bills or savings accounts. 2. 2. - Consider Tax Impacts:
If you are in a high tax bracket, look at municipal bonds. If not, explore other bond options for potentially better returns. - Reallocate Some Savings:
Consider moving 20-30% of your T-bill investments into ultra-short bond strategies. This can help you stay ahead of interest rate cuts. - Stay Informed:
Keep an eye on economic news, especially announcements from the Federal Reserve. These updates can guide your investment decisions. - Review Regularly:
Make it a habit to review your investments every few months. Markets change, and your strategy should adapt accordingly.
Protect your future by making smart choices today
The financial world is always changing, and your savings strategy should evolve with it. As interest rates start to drop, it is time to rethink where you are keeping your money. By exploring ultra-short bonds, considering tax impacts, and adding corporate bonds to your portfolio, you can keep your money working for you—even in a lower-rate environment.
Remember, a financial advisor can provide personalized advice to help you make the best decisions for your unique situation. But the key takeaway is this: Do not let your money sit idle. Make it work smarter for you.
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Disclaimer:
The information and examples provided in this article are for general educational purposes only. They are not intended as financial or investment advice. Readers are encouraged to consult with a professional advisor for personalized guidance based on their individual financial situation. The author and Confluent Asset Management are not liable for any actions taken based on this content. Past performance is not a guarantee of future results.
