Finance
How investors can prepare for lower interest rates
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Federal Reserve Chairman Jerome Powell.
Andrew Harnik | Getty Images
Federal Reserve Chairman Jerome Powell gave the clearest indication yet on Friday that the central bank is likely to start cutting interest rates, which are currently at a two-decade high.
If there is a rate cut in September, as experts expect, it would be the first time officials have cut rates in four years, when they cut them to near zero at the start of the Covid-19 pandemic. A
Investors may be wondering what to do on the eve of this policy change.
Those who are already well diversified likely don’t need to do much at this point, according to financial advisors on CNBC’s Advisory Board.
“For most people, this is welcome news, but it doesn’t mean we’re making major changes,” said Winnie Sun, co-founder and principal of Sun Group Wealth Partners, based in Irvine, California.
“It’s kind of like getting a haircut: We do little haircuts here and there,” she said.
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Many long-term investors may not need to do anything at all — such as those who keep most or all of their assets in a target-date fund through their 401(k) plan, advisors say.
Such funds are supervised by professional asset managers who are equipped to make the necessary adjustments for you.
“They do it behind the scenes on your behalf,” says Lee Baker, a certified financial planner and founder of Claris Financial Advisors, based in Atlanta.
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That said, there are some adjustments that more practical investors can consider.
These adjustments would largely apply to cash and fixed-income investments, and perhaps also to the types of stocks in one’s portfolio, advisers said.
Lower interest rates are ‘positive’ for equities
In his keynote address on Friday at the Fed’s annual retreat in Jackson Hole, Wyoming, Powell said “the time has come” to adjust interest rate policy.
This announcement comes as inflation has fallen significantly from its pandemic-era peak in mid-2022. And the labor market, while still relatively healthy, has hinted at signs of weakness. A cut in interest rates could take some of the pressure off the US economy.
The Fed will likely choose between a 0.25 to 0.50 percentage point cut at its next policy meeting in September, Stephen Brown, deputy chief economist for North America at Capital Economics, wrote in a note Friday.
Lower interest rates are “generally positive for equities,” says Marguerita Cheng, CFP and CEO of Blue Ocean Global Wealth, based in Gaithersburg, Maryland. Companies may feel more comfortable expanding if financing costs are lower, for example, she said.
But the uncertainty surrounding the number of future rate cuts, as well as their size and pace, means investors should not make major changes to their portfolios as a knee-jerk reaction to Powell’s proclamation, advisers said.
“Things can change,” Sun said.
Importantly, Powell did not commit to cutting rates, saying the path depends on “incoming data, the evolving outlook and the balance of risks.”
Considerations for cash, bonds and stocks
Falling interest rates generally mean investors can expect lower returns on their ‘safer’ money, advisers say.
This also includes relatively low-risk assets, such as cash in savings accounts, money market funds or certificates of deposit, and money in shorter-term bonds.
High interest rates meant that investors enjoyed fairly high returns on these lower-risk investments.
It’s kind of like getting a haircut: we do little haircuts here and there.
Winnie sun
co-founder and director of Sun Group Wealth Partners
However, such yields are expected to fall along with falling interest rates, advisers said. In general, they recommend locking in high guaranteed rates in cash now while they are still available.
“It’s probably a good time for people thinking about buying CDs from the bank to lock in the higher rates over the next twelve months,” said Ted Jenkin, a CFP and the CEO and founder of Atlanta-based oXYGen Financial .
“A year from now you probably won’t be able to renew at the same rates,” he said.
Others may want to park excess cash — amounts that investors don’t need for short-term expenses — in higher-paying fixed-income investments such as longer-term bonds, says Carolyn McClanahan, a CFP and founder of Life Planning. Partners in Jacksonville, Florida.
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“We’re really committed to making sure customers understand the interest rate risk they’re taking on by staying cash,” she said. “Too many people don’t think about it.”
“In six months they will be crying when interest rates are a lot lower,” she said.
The term of a bond is a measure of a bond’s sensitivity to interest rate changes. The term is expressed in years and takes into account the coupon, the term and the return paid during the term.
Short-term bonds – with a term of perhaps a few years or less – generally pay lower returns but carry less risk.
Investors may need to increase their term (and risk) to keep interest rates at the same level as the past two years, advisers say. A term of five to 10 years is probably OK for many investors right now, Sun said.
However, advisors generally do not recommend adjusting the allocation of stocks and bonds.
But investors may want to invest more future contributions in different types of stocks, Sun said.
For example, stocks of utility and home improvement companies tend to perform better when interest rates fall, she said.
Asset categories such as real estate investment trusts, preference shares And small-cap stocks also tend to do well in such an environment, Jenkin says.