Building a Yield Ladder to Safety

Cash may be king, but it earns a peon’s wage.

If your cash is moldering away in an account awaiting the fabled Green Light of Safe Investing, its yield is closer to ignoble than royal. According to Bankrate.com, the national average yield on checking accounts is 0.08 percent. Move it to a savings account and you’ll get 0.09 percent.

You won’t find those rates at our wonderful Too-Big-To-Fail banks, of course. Chase, Bank of America and Wells Fargo currently offer exactly the same 0.01 percent on their checking accounts, but caution that you’ll need to keep a balance of $10,000 to $15,000 to avoid fees. Citibank goes all out and offers 0.03 percent. Whatever you do, keeping $10,000 on deposit for an entire year will get you no more than a single item from the McDonald’s dollar menu.

Things aren’t much better for the cash in your brokerage sweep account. These accounts, which hold cash used in transactions, are similar to bank checking accounts with a slightly better yield. Fidelity now pays 0.31 percent on its brokerage sweep accounts, while Schwab pays 0.30 percent. Vanguard does notably better, offering the Vanguard Federal Money Market Fund (ticker:VMFXX) for its sweep accounts, with a recent yield 2.18 percent.

Longer term commitments don’t help much, either

You won’t do much better by making a time commitment, either. Here’s how average bank CDs compare with same-maturity Treasury yields:

— 1-year average bank CD rate 0.72% vs. 1-year Treasury 2.70%

— 2-year average bank CD rate 0.94% vs. 2-year Treasury 2.83%

— 5-year average bank CD rate 1.29% vs. 5-year Treasury 2.89%

Remember that difference the next time your bank runs a sentimental ad about how hard they work to serve you.

Mutual fund and ETF shares bring interest rate risk

Those are average rates, of course, so some banks do offer higher yields. But if you visit the Bankrate.com pages, you’ll find that their featured yields are at, or slightly below, Treasury yields. A (literal) handful of banks offer higher rates.

Worse, things don’t get better if you commit to a mutual fund or exchange-traded fund that invests in longer-maturity investments. The iShares 1-3 Year Treasury Bond ETF  (ticker: SHY) currently has an SEC yield of 2.70 percent — but its total return year to date has been only 0.60 percent, due to rising interest rates that depress the prices of fixed-income securities. Similarly, the Vanguard GNMA fund (ticker: VFIJX) recently offered an SEC yield of 3.12 percent — but its total return year-to-date has been a loss of 0.99 percent.

The purgatory of cash

Cash, and all the folks who hold it, live in a kind of investment purgatory. Low yields from retail banks are bad enough. But the possibility of further increases in interest rates makes going for longer term commitments risky.

What can we do?

Answer: This is a good time to build yield ladders using U.S. Treasury obligations.

“What’s a yield ladder,” you ask?

Building a fixed income ladder

It’s a series of securities that mature at regular intervals. As a consequence, you’ll always have something close to maturity. So if you have an unexpected need for cash, you won’t have to sell at a loss, something you are likely to experience with any fixed-income mutual fund in a period of rising interest rates.

Fortunately, the U.S. Treasury makes life easy with regular offers of bills, notes and bonds of different maturities. You can buy them, free, through your brokerage account, including the brokerage account that holds your 401(k) or 403(b) rollover.

Here’s a simple start.

A three-year Treasury ladder

Start by buying equal amounts of a one-year Treasury bill, a two-year Treasury note and a three-year Treasury note. Recent yields, according to the Daily Treasury Yield Curve Rates on the Treasury.gov website, were 2.70, 2.83 and 2.86 percent, respectively. That’s an average yield of 2.80 percent.

After the first year, reinvest the proceeds from the matured Treasury bill (less accrued interest) in a new three-year note. Do that every year and you’ll enjoy three-year note yields — but your ladder will have an average maturity of no more than two years. A bit more yield, but a good deal less risk.

One action, once a year, does it.

A five-year or seven-year ladder

 You can build a five-year ladder over a two-year period by buying three one-year bills, and notes with two-, three-, and five-year maturities. After a year, invest the maturing one-year bills in a new three-year and a five-year and you’ll have a five-year ladder.

It will have an average maturity less than three years while providing the yield of five-year notes. As with the three-year ladder, once established it requires only one action, once a year.

You can do much the same to build a seven-year ladder.

Once established, the only effort required is to roll the maturing note into a new obligation that is the longest in the ladder.

As a Required Minimum Distribution Solution

 At the height of the financial crisis, the need to take a required minimum distribution was suspended for a year because selling would have forced market prices even lower. You can avoid some of the angst of taking distributions in a bear market by establishing a ladder. You’ll always know that you have securities maturing to cover the cash you need to withdraw. You can do it for years before needing to sell any equities.

Will this make you a bond wizard?

No, but it will put you in control of your money. That’s a good thing.

Sources and References:

For current Treasury obligation yields: https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield

For more information on buying and owning U.S. Treasury securities:

https://www.treasurydirect.gov/instit/research/faqs/faqs_basics.htm

Bankrate.com  CD rates page: https://www.bankrate.com/cd.aspx

Bankrate.com Savings account rates page: https://www.bankrate.com/banking/savings/rates/

Note: all yields in the column were from web postings on 11/28/18

This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.

Photo: by Samuel Silitonga from Pexels

(c) Scott Burns, 2018