Opportunity Cost and Fixed Income Investing: Invest Now or Wait?

The Federal Reserve hiked the Fed funds rate 3 times in 2017 and projected 3 more hikes for 2018. Should you consider investing in fixed income?

Print
https://tickertapecdn.tdameritrade.com/assets/images/pages/md/Time: How opportunity cost could affect fixed income investments
2 min read

We’re familiar with the saying “nothing ventured, nothing gained.” At least nothing is lost, either, right? But in some cases, the “nothing ventured” choice may come at a cost—opportunity cost, or “the cost of waiting.”

When it comes to interest-bearing securities such as certificates of deposit (CDs), bonds, and other fixed income securities, keeping cash on the sidelines may mean time is passing but some assets aren’t earning interest.

The Federal Reserve raised the Fed funds rate three times in 2017, each time by a quarter-point, and has projected three more such hikes in 2018. Some investors might look at this tightening cycle as a reason to wait. After all, investors a higher rate, right?

The Cost of Waiting

Because fixed income investments pay interest, many investors look for securities that offer the highest yields (the income return of an investment), meaning that some investors will try to time the market. For example, they might wait for the Federal Reserve to hike interest rates before jumping in to invest. But such hesitation comes at a cost: if speculative efforts to time the market don’t work out, meaning that the expected yield doesn’t appear, then investors may have missed out on income opportunities. (If you’re unfamiliar with the basics of fixed income investing, please refer to this recent primer).

For example, suppose you have the opportunity to invest $100,000 into a fixed income security yielding 3% annually, with a maturity date 10 years from the time of purchase. And for simplicity’s sake, we’ll assume no compounding of interest.

Here are a few hypothetical scenarios. Each assumes you’ll hold your investment through to maturity (10 years). Remember that selling your investment before maturity may result in a loss of principal, as explained in this beginner’s guide to fixed income investing.

Scenario 1: You decide to invest now.
Say you invest $100,000 in a fixed income security yielding 3%, as described above. At the end of 10 years, you will have generated a total income of ($100,000 x 10 years x 0.03) = $30,000.

Scenario 2: You wait one year and invest in a fixed income security yielding 3.25%.
Interest rates have risen. After a year of sitting on the cash, you find an opportunity to invest $100,000 into a security yielding a higher rate of 3.25%. At the end of your original 10-year period, you would have earned 9 years’ worth of interest, having skipped the first year. This will give you an income total of $29,250. That’s $750 less than what you would have earned in the previous scenario—not bad, but still short. Of course, this is just one potential scenario in which yields have moved in your favor.

Scenario 3: You wait one year and yields fall.
Suppose you decide to hold off a year in anticipation of higher interest rates. But instead, the economy stalls, and interest rates fall. Now you’re facing lower yields. Instead of that 3% yield of yesteryear, a similar low-risk security may yield, say, 2.75%. At the end of your original 10-year time frame, after having waited a year, your income will be only $24,750—$5,250 less than the original investment opportunity.

You might be tempted to sit on the sidelines in anticipation of higher yields. But just remember that attempts to time the market are fraught with uncertainty. 

Call Us
800-454-9272

Investments in fixed income products are subject to liquidity (or market) risk, interest rate risk (bonds ordinarily decline in price when interest rates rise and rise in price when interest rates fall), financial (or credit) risk, inflation (or purchasing power) risk and special tax liabilities. May be worth less than the original cost upon redemption.

adChoicesAdChoices

Market volatility, volume, and system availability may delay account access and trade executions.

Past performance of a security or strategy does not guarantee future results or success.

Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.

Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.

The information is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.

This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.

TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2018 TD Ameritrade.

Scroll to Top