Are Floating Rate Notes (FRNs) Right for your Fixed Investment Class?
Investors are scrambling to find a decent yield for the fixed (bonds and cash) portion of their investment portfolio‘s. With the hint (or likelihood) that rates will be rising, most investors are frightened to hold medium or long term bond funds. (With a medium term or longer term bond fund, when interest rates rise, the value of the fund will fall much more than with a shorter term bond fund.)
But with savings yields, certificate of deposit rates, and short term bond funds barely yielding 1% where should an investor put her short term cash allocation?
The government has some great investment vehicles for savers; I bonds, TIPs (treasury inflation protected securities), Treasury bills, notes and bonds. Treasury investments are safe. It’s unlikely that the U.S Government will fall and if it does, we’re all in big trouble.
In “The Best New Savings Vehicle You’ve Never Heard Of” at US News and World Report, I wrote about these investments and I can’t talking about them. You’re probably not going to hear about them from your investment advisor.
Floating Rate Notes Due to Launch Soon
The government will be offering these investments soon and here’s why you might want to check them out.
” Issued for a term of two years, FRNs will pay varying amounts of interest quarterly until maturity. Interest payments will rise and fall based on discount rates in auctions of 13-week Treasury bills.” TreasuryDirect.com
A minimum of $100 gives you access to a floating rate note (FRN). These notes mature in 2 years but can be redeemed any time after 45 days at market value. Here’s the big selling point, if interest rates rise, your return on the FRN rises as well. So you’re not locked in to a low rate investment.
The interest rate “floats” and is tied to the rate of the 13 week Treasury bill. The rate floats or adjusts, weekly but interest is paid quarterly.
These notes can be bought through the Treasurydirect.gov website, where you can also buy I bonds, TIPs. and other Treasury securities.
Should You Invest in Floating Rate Notes?
A better question is, “Why not invest in floating rate notes?”
If you answer “yes” to these questions, consider investing in a floating rate note.
1. Do you think interest rates may rise during the next 2 years?
2. Would you like the opportunity to place your cash in a savings vehicle which increases your return when market rates go up?
3. Are you looking for a very safe investment for your cash?
4. Is your credit card debt paid off? If not, pay it off first. That’s the best place for any extra cash.
5. Can you leave the money invested for at least 45 days?
6. Are you looking for a cash investment with a low ($100) required minimum investment.
7. If interest rates decline, are you willing to accept a lower market interest rate?
Should You invest in a Floating Rate Treasury ETF?
Exchange traded funds (ETF) are a type of mutual fund that can be bought and sold on financial exchanges throughout the day. They are quite popular due to their low fees and high liquidity. It’s no surprise that investment companies are already planning their FRN exchange traded funds.
“State Street Global Advisors, the second largest ETF issuer in the U.S. by assets, has put in a registration for a fixed-income ETF that would serve up access to floating-rate Treasury’s—a brand new security that doesn’t come to market until January of 2014.
The SPDR Floating Rate Treasury ETF, which will have its primary listing on NYSE Arca with the ticker “FLTY,” will track an index comprised of floating rate U.S. Treasury notes through representative sampling. Fees weren’t disclosed in the preliminary prospectus filed with the Securities and Exchange Commission last week.” Cynthia Murphy in SSGa Plans Floating Rate ETF at Index Universe.com.
Index Universe.com had a nice write up on the upcoming FRN index fund. Like any good opportunity, competition is in play. WisdomTree Floating Rate Treasury Fund is due to launch soon as well. I’m sure there will be more FRN mutual and exchange traded funds to come.
So, is a FRN fund right for you?
If you want an easy alternative to investing in individual FRNs, an ETF might be the solution. The advantage is that you won’t need to bother with turnover at the end of two years. Just buy the fund, request dividend reinvestment and that’s it.
The down side of this and any bond fund is the reverse of the advantage. When you want to sell shares, the value of your investment may be greater or lesser than your original purchase. ETFs may sell at a premium or discount, which means the fund might sell for more or less than its underlying value. On top of that, it is possible that with changes in interest rates, the principal value will either increase (with a decline in interest rates) or decline (with an increase in interest rates). Although, since FRNs have two year maturities, the principal value shouldn’t vary much.
Then there are expenses. Usually fees and expenses are quite low with index ETFs and mutual funds, likely lower than 0.40% or even less. (Please do not hold me to this fee estimate)
The hands off investor may appreciate the opportunity to invest in the ETF and be done with the monitoring and managing, whereas the more active investor may be quite comfortable holding individual floating rate notes.
Action Steps
- Put a reminder on your planner in February to visit Treasurydirect.gov and read about the floating rate notes.
- If you decide they are a good investment for the cash or fixed portion of your portfolio, start investing.
There’s no advantage to procrastination since when rates go up, so will your return!
On a personal note, I look forward to transferring some of our family’s cash assets to floating rate notes as soon as this safe, government investment is available.
Caveat: This is neither a recommendation to buy or sell any investment. When making investment decisions, consult your own personal financial advisor.
Where are you investing your cash assets these days?
image credit; etftrends_google images
