According to GFOA's Sample Investment Policy, how can interest rate risk be mitigated?

Mitigating interest rate risk is crucial for managing a public entity’s investment portfolio, and structuring the portfolio with maturities that align with cash needs is the most effective approach. By matching the maturities of securities in the investment portfolio with anticipated cash flow requirements, an entity can reduce the impact of interest rate fluctuations. This strategy helps ensure that funds are available when needed, thereby minimizing the need to sell securities before maturity, which could result in losses if interest rates rise.

When cash needs are synchronized with the maturity schedule of investments, it protects against the risk of having to liquidate long-term securities at unfavorable rates during periods of rising interest rates. This proactive strategy provides both liquidity and stability in the portfolio, allowing for a more predictable financial position.

In contrast, limiting investments solely to the safest types of securities or diversifying the portfolio does not directly address the timing of cash needs and can still expose the portfolio to interest rate fluctuations. Investing primarily in longer-term securities can increase exposure to interest rate risk, as these securities are more sensitive to rate changes. Thus, structuring the portfolio to align with cash needs stands out as the most comprehensive method for managing interest rate risk effectively.