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What to do when there is a flat yield curve

July 31, 2018

The previous blog explained yield curves. I felt it was important to post what it is so my readers would have an awareness of it, since it will likely be more in the news if the curve flattens out further. However, I received a few calls questioning what it means and if there is any relevance to the average investor, so here is today’s column.

I do not recommend that the average nonprofessional investor do anything about it. It is an economic phenomenon that occurs occasionally in the ever present economic cycles. At some point it will right itself out.

It is normal to have a yield curve with longer term rates greater than the short term rates and when that is not the case, then either the short term rates will decline or long term rates will increase (or a combination of directional moves) getting the curve back to normal. It is actually not that complicated; the rate structure will change and the differences will widen.

Right now, bank certificate of deposit rates are higher than they’ve been for a number of years, and I have been suggesting CDs for shorter term investors. For fixed income investors for longer terms, i.e. over 5 years, I am suggesting fixed annuities up to about 8 or 9 years and then corporate bonds for longer periods. CDs and annuities are quite easy to buy; bonds are more difficult.

Because of the difficulty in acquiring bonds, many people invest in bond funds or index funds. I do not suggest this since the funds’ values will fluctuate and will certainly decrease if interest rates increase. Actual bonds will also fluctuate in value, but at the end of the term, assuming no default and the bonds are retained, the principal will be repaid. That is not the case with the bond funds where there is no “end of the term”. My only warning with actual bonds is to only buy them if you are very certain you will not have to sell them prior to maturity. See previous blogs on how to handle long term bonds.

A comment I get from many of my older clients is that they do not want to buy longer term bonds since they might not live that long. Well, I have news for most of you; hopefully you are in a position where you will outlive your money. If you won’t, then you have a problem that needs to be addressed sooner, rather than later. So assuming your investments are such that they will survive you, then what is the problem with buying long term bonds? The longer term bonds should provide a greater cash flow than the shorter term CDs and it is the cash flow that you are living off of; not really the asset values.

Flattening yield curves are interesting to see and talk about, but unless you are an active bond trader, should be of no concern. Secure investing for cash flow should be your focus. Pay attention to what can affect you, and be interested or curious at what won’t, but do not be overly concerned about it.

One Comment leave one →
  1. Steven Oberg permalink
    July 31, 2018 8:42 pm

    Thanks Ed. Good info and advice.

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