The 10-year Treasury has jumped nearly 75bps since Donald Trump’s election. If you talk with some economists, they’ll say the rate increase will continue; others predict a softening of rates back to the average over the past three years. The Fed has indicated they would like to see rates above 3 percent by 2019. In reality, we simply do not know where rates are going—short term or long term.
So, what should you do with your clients in an uncertain rate environment? I suggest you take advantage of this uncertainty and talk to your clients about how to properly mitigate interest rate risks—now and in the future. As rates were falling In the first half of 2016, we saw a significant increase in 5-year multi-year guarantee annuity sales. Advisors were trying to lock in clients for a period of time while the 10-year Treasury fell precipitously throughout the first six months of the year. However, we need to take advantage of the time to change the conversation with interest rates.
Instead of reacting to rate changes and chasing the rate environment, try to begin repositioning the interest-driven portion of your portfolio for success, regardless of the rate environment. I think this can best be done using the simple concept of laddering, a viable tactic to take advantage of any rate environment. It’s a simple move that places your financial vehicles at different maturities over a certain time frame. Once the short-term vehicle matures, you reposition it to the longest maturity available. When the next shortest-term instrument matures, you reposition it for the same long-term maturity. After going through your initial investments, you have laddered your portfolio.
The result of doing this creates liquidity and better rates. Your client is now positioned with all of the interest-driven assets at the longest portion of the yield curve—the part with the historically highest rates and yields. At the same time, you have a steady source of cash if the client needs liquidity. By positioning a pocket of money annually in a ladder, the client has liquidity to a portion of his or her portfolio each year. If the client believes more will be needed, simply position a larger percentage in each pocket of money and, perhaps, shorten the long-term maturity. A lower yield is the likely cost of more liquidity.
Thinking about long-term solutions for interest-rate risk is sorely needed now—not because of a rising interest-rate risk but because we must move away from transaction-based solutions. Your clients will appreciate the value you have added to the relationship with an actual solution versus worrying about an uncontrollable event such as a change in interest rates.
Look at laddering the fixed income portion of your portfolio regardless of financial vehicle. Putting your clients in the highest yield position with liquidity requires some repositioning but makes sense now and in the future.