Giving Low Risk Investments a High Profile

In most financial media, the flashy and high risk items usually get the front page prominence. However, what is if you do not have a lot of money to invest or a short time horizon? That is when low risk investments usually enter the conversation. Jose Torres, Interactive Brokers’ Senior Economist joins Cassidy Clement, Senior Manager of SEO and Content to discuss.

Summary – Cents of Security Podcasts Ep. 58

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Cassidy Clement 

Welcome back to the Cents of Security podcast. I’m Cassidy Clement, Senior Manager of SEO and Content at Interactive Brokers. Today, I’m your host for our podcast, and our guest is Jose Torres, Interactive Brokers’ Senior Economist.  

In most financial media, you’ll probably hear about flashy and high-risk investments. They tend to get the front page views and the prominence for, you know, your media journalists and TV shows.  

But what if you don’t have a lot of money and what if your short time horizon is the barrier? A lot of investors don’t necessarily look at low risk or low time horizon investments because sometimes they’re not part of the conversation. 

So while listeners might have briefly heard about it, today Jose and I are going to talk about it even more. So welcome back to the program, Jose.  

Jose Torres 

Hi, Cassidy. Great to be here.  

Cassidy Clement 

I know that you have a little bit of background in this industry of managing things that are a little bit more fixed to a timeframe and low risk, but what exactly did you focus on when you were in that industry? 

I know you had some FDIC industry experience.  

Jose Torres 

Sure. So I was on the economics team at the FDIC and part of the FDIC responsibilities there were to protect the deposit insurance fund or otherwise known as the DIF. D-I-F. And those funds are used to ensure depositors to make sure that if there’s a bank failure, things can get settled. 

There was constantly a focus on which banks had the most exposures to assets that were underperforming. There was constantly emphasis on how much money was parked in the shorter end of the curve and the belly of the curve, long end of the curve as well. And also there was focus on macroeconomic shocks, inflation, employment, all the kinds of major economic indicators that investors like to follow as well. 

Cassidy Clement 

As I mentioned before, most listeners probably have heard of all the flashy and high-risk investments. They’re the ones who get the prominence, but you know, what exactly, when it comes to low risk investments, make them low risk or short time horizon investments? Is it a timeframe? Is there a risk rating or maybe some type of like a sector that’s considered the risk or short timeframe? 

Jose Torres 

Well, here’s really, I think the fundamental point. Am I going to lose money? Right? That’s really the most important component when you’re considering risk.  

So we narrow into the fixed income world, right? And that can be bank deposits, that can be certificate deposits, and those two aren’t necessarily securities, but they operate similarly. 

And then you have treasury notes, treasury bonds, you also have corporates, you also have sovereigns, you have municipals, right? You have a long list of fixed income investments, both securities and bank products that you can choose from. How can you lose money on a fixed income investment? There’s a few ways. 

One of them is that the issuer doesn’t pay back, right? So you lend, let’s say $10,000 to a corporation that’s not an investment grade. Not an investment grade means that maybe they’re a little riskier. More of a speculative way that you’re going to get your money back. And if they don’t pay you your money back, then you’re taking capital losses. 

That’s one way to lose money in the fixed income market.  

Now, another way to lose money is if you lend for a long period of time, and then interest rates increase rapidly. So, if I buy a corporate bond over 10 years, let’s say it’s paying 6%, but then long term interest rates go up 200 basis points or 2% to where now those freshly issued corporate bonds of the same quality, instead of paying six, now they’re paying eight for me to get rid of those bonds that I bought at six. Because the new market, the fresh market investors that have capital to deploy have access to that same quality at 8%, now I have to take losses if I want to get liquid, right? And that’s an important risk that’s often overlooked, not just in the economy, but specifically in the banking sector is interest rate risk. 

If I park money over long durations and interest rates spike, right, what do my capital losses look like?  

Final point here, that’s exactly what went on with Silicon Valley Bank back in March of 2023. They had some excess capital, excess cash on the books. They were looking to juice up earnings in the short term and they went out and they parked money in safe securities, right? Treasury notes and bonds that maybe there are 10, 20, 30 years. So they’re particularly safe, but the balances can move quite volatilely.  

The balances can move quite sharply when money’s tied up for that long, because during that period, the 10 year yield or what the U S government pays interest on over a 10 year horizon on those notes went from roughly 1.5% all the way to roughly 4.2, 4.3% at that time, right?  

And then later in the year, in November of 2023, they went up to 5%. So if you had 10 year notes and you bought them originally for 1.7%, 2%, 2.5%, even 3%, today, they’re at 4.2%. So those positions are carrying losses.  

Cassidy Clement 

You had mentioned in your explanation there some things like corporate bonds and then also Silicon Valley Bank, which was a very big financial media headline for several months. 

What are some examples of popular low risk investments or the low time frame investments and how exactly do they differ? I know you said corporate bonds like I mentioned, but outside of that, I don’t know necessarily of people on the street being able to name more than five, you could say, but then maybe the seasoned investor knows more. 

Jose Torres 

Sure. So I would say some popular products and, you know, this new higher for longer kind of interest rate regime is something that’s arrived post pandemic, you know, we haven’t seen rates this high in the short end of the curve for a long period of time, but now that they are this high, we’re seeing increasing popularity in brokerage accounts, for example. For example, here at Interactive Brokers, we pay, you know, up to 4.83% on cash balances in an account.  

Those are becoming very popular. Also, we have certificate of deposits around the entire economy. If I give a bank money for six months, one year, two years, three years, I’m getting now paid, I’m getting paid 4.5, maybe 5% on those funds over that time period. 

You have money market accounts, which are very liquid and they’re investing in short term instruments like T-bills, like CDs, which I just mentioned. Also reverse repo facilities at the Fed that you can park cash at overnight and get paid daily, right?  

But the idea with money market funds is that they’re very liquid. So as soon as investors need cash, they can have it right away. In fact, they could even write checks on many of those accounts.  

So those are some popular items that have, instruments rather, that have come around, that have been around for a long time, but their popularity has begun to increase because folks can now actually earn a strong level of interest income when they give their money to a bank or to a brokerage firm, or if they park overnight at the Fed’s facility.  

Cassidy Clement 

Is there a general investor profile for those types of investments? You mentioned a handful that may vary on timeframe, but then there’s also the aspect of how much you invest versus the interest rate, which you kind of alluded to there. 

You know, is there a certain type of investor or person that would fit into that investment better than others?  

Jose Torres 

Oh, absolutely. If you’re looking to make 100%, 200%, 300%, you know, you love the meme stocks, you love Bitcoin, you know, you’re not going to be phased by 4,5,6%, right? That’s not going to lure you in. 

However, if you need money because you’re going to buy a house in nine months or 12 months, and you don’t want your savings to just earn zero during those nine months, right? All of a sudden, these kinds of short term, low risk investments like T-bills, which are fixed income instruments that are issued by the United States government that mature in no later than 12 months, right? 

Theoretically, we consider that risk free in the financial econ world, because they’re issued by the U. S. Government. Also, CDs. Certificate of Deposits, those are insured by the FDIC, the Federal Deposit Insurance Corporation. So they’re also kind of, you know, labeled risk free.  

And then money that’s parked in the Fed via reverse repo, that’s also theoretically considered risk free. So it’s really for people that are not looking to swing it out of the park, right? You don’t swing it out of the park with 4 or 5%, right? It’s for people that need money, they don’t want to lose their money, and maybe they need money in the short period of time. 

Now, one other category of investor, Cassidy, is also someone that wants to park money at five or ten years, but is scared that interest rates are going to spike. They look at the world, they see that governments have been borrowing from their future to finance the short term, right?  

And they think that in the medium to long-term, five-year bonds, ten-year bonds, twenty-year bonds, the interest rates on those things are going to shift significantly higher. 

So they don’t want to park money for five years, ten years, twenty years, because they think that interest rates are going to spike, if that does occur, if that does manifest, all of a sudden, when they look at their account, their balance is going to go down tremendously, because they’re tied up over ten or twenty years. 

They took a lot of interest rate risk. So a lot of times they’re waiting in the short end of the curve. They’re buying T-bills that expire in three months, four months, five months. When interest rates do spike, then they’re like, oh, okay. 5%, I kind of like that. Let me lock in at 5% over five or 10 years. 

It’s for the safe investor. But also for the opportunistic investor.  

Final point here, Cassidy, you have TIPS, Treasury Inflation Protected Securities. And those are some folks that want to take the inflation uncertainty out of their treasury book. So what they’ll do is they’ll buy TIPS. Of course, it won’t be as rewarding in a best-case scenario, but they are protected in case inflation shoots higher. 

Cassidy Clement 

So with these low risk investments, I mean, you kind of said there’s several different items involved that could be alluring to you or maybe help balance out some of your portfolio.  

But, you know, other than the interest rates, which you can follow and generally get an idea of for how long your money has to be in there, how much you will gain, give or take on that investment. 

Is there a reason that these investments would not be the right move for people with certain goals? Like is there, you know, any penalty to taking money out before you hit a maturing date? You know, these are some of the questions that I would ask if I was investing, but like from your perspective, are there certain questions that investors should ask themselves before getting involved into a low-risk investment for their chunk of change that they’re hoping to get back very soon? 

Jose Torres 

These investments don’t get you rich overnight, right? You gotta really bring in your expectations if that’s what you’re looking for. It’s more of a steady Eddie. I either want to keep my cash safe, but I don’t want it to lose purchasing power. One.  

Or two, I do want to park money for longer durations, but I’m scared that interest rates are going to rise significantly and then I start taking capital losses because of that increase in borrowing costs. Now with certificates of deposits, those are bank products. So those things are.. you’re vulnerable as an investor if you sign for two years and you want your money back in three or four months, right? So you have to ask what the penalties are. 

That’s a really important component of CDs. Of course, with more liquid products like treasury bills or money markets, right? They have a maturity of two or three months on the T-bills. You know, you can just sell them after one month or after 60 days or whatever. So, right, you don’t really have that tight of a lockup period. 

You could get rid of them if you need to.  

One more thing, Cassidy I want to talk about here. There’s also some CDs offer really high interest rates. But if interest rates go down, they’re callable. This happens with bonds too. They’re callable. So I’m the issuer and Cassidy has some money and shewants to earn interest so she comes to me and she’s like, ooh, I like those interest rates you have on those CDs. You know, 5. 4% is really high. As the issuer in the fine print, or if she comes in, I have to explain to her that, yeah, they’re high, but they also have a call provision.  

If in six months, I feel like it, if rates go down, I’m just going to give you your money back and try to issue those CDs to someone else at a much lower rate. 

Why?  

Because I don’t want to pay you that much interest if I don’t have to. Typically if you go on your Interactive Brokers’ scanner, you look for CDs, by the way, ladies and gentlemen, you can buy, invest in CDs here at Interactive Brokers.  

If you go on your scanner and look at CDs and you rank them from the highest yield to the lowest, you will actually realize that some of the highest yields have the callable feature, right, where they’ll send you your money back because they don’t want to pay you that much interest. 

So that’s another important consideration there.  

Cassidy Clement 

So, with all of that you mentioned, just thinking for the listeners here, you know, are there some examples of ways that these investments would be used? I know you talked about saving for a house or saving some money towards a car or something like that. 

You know, how are some of these used in day to day? Some people sit on stock portfolios for ever and their investment goals might be different than other people, but you know, these shorter term items and they’re tending to be a little lower risk because the reward also is not that high. What are some examples of the ways that people use these? 

Jose Torres 

Yeah. So insurance companies love them because a lot of times they need money in the short term, but they don’t want to lose the interest income possibilities, despite needing cash in the short term. So they love these kind of money market CD-like instruments.  

And a lot of folks, if you have checking accounts with the big banks, a lot of them don’t really pay levels of interest that are even close to short term rate when you look at what the Fed’s paying, or when you look at what banks are charging each other, or when you look at what the US government is paying someone that’s lending at one month or three months or six months, right?  

They’re not even close.  

In fact, some of the big banks are paying 0, 0.5%, 1%. But, Cassidy, the technology keeps the customers there, right? They love the technology. They love the “Zelle-y” aspect. They can send money. They can do this. They can split this. They have a lot of technology. The big banks from a depositor perspective have the technology edge over the smaller banks. 

But what a lot of people are doing, if they have like a sizable amount of money in their checking account, let’s say their bills are $3,000 a month, right, but they have $20,000 in their checking account, they’re saying, well, hold on a second, let me take $14,000, and let me throw it into an Interactive Brokers account. That’s going to give me a pretty high yield of 4.83% on my cash balances. And even higher if I commit to a particular bond or a CD or anything like that. It doesn’t make sense for me to keep my money in my checking account and make 0.5% when I can make interest income rise significantly, right? 

We’re talking 400 basis points here, roughly 4% full. In some cases higher. Why should I have all this money stashed in the checking account? And that’s one thing that we’re seeing. And generally speaking, anyone that does not want to lose to purchasing power, continuing to decline on a dollar-for-dollar basis, still wants to make interest income on their savings, but still wants liquidity and still wants the access. 

Cassidy Clement 

That’s actually part of the reason that I chose this topic was to myself and many people I’ve talked to, it’s just the reality of, oh, well, you know, if you were saving for a bigger purchase, the checking or savings account area isn’t as interest intensive if you will, to make some money if you have a chunk of change in there. 

And I think a lot of people don’t realize there are some ways out there to help your money work for you, even if you only have six months or something like that to make some investment that might not be as flashy as, like you mentioned, talking about meme stocks, but it’s better to at least have it be accessible and make something off of it than necessarily nothing. 

So thanks for joining us today, Jose.  

Jose Torres 

Absolutely. My pleasure. Thanks for having me.  

Cassidy Clement 

Sure. So as always, listeners can learn more about an array of financial topics for free at www.interactivebrokers.com. Follow us on your favorite podcast network and feel free to leave us a rating or review.  

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