How investors can prepare for lower interest rates

Federal Reserve Chairman Jerome Powell on Friday gave the clearest indication yet that the central bank is likely to begin cutting interest rates, which are currently at their highest level in two decades.

If a rate cut comes in September, as experts expect, it would be the first time officials have cut rates in more than four years, when they cut them to near zero at the start of the Covid-19 pandemic.

Investors may be wondering what to do on the precipice of this policy change.

Those who are already well-diversified probably don’t need to do much now, according to financial advisors on CNBC’s Advisory Board.

“For most people, this is welcome news, but it doesn’t mean we’re making big changes,” said Winnie Sun, co-founder and managing director of Irvine, California-based Sun Group Wealth Partners.

“It’s like getting a haircut: We make little cuts here and there,” she said.

Many long-term investors may not need to do anything at all — such as those who hold most or all of their assets in a target-date fund through their 401(k) plan, for example, said counselors.

Such funds are overseen by professional asset managers equipped to make the necessary changes for you.

“They do it behind the scenes on your behalf,” said Lee Baker, a certified financial planner and founder of Atlanta-based Claris Financial Advisors.

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That said, there are some tweaks that more active investors may want to consider.

Mostly, those changes would apply to cash and fixed-income holdings, and probably to the types of stocks in one’s portfolio, the advisers said.

In his keynote address on Friday at the Fed’s annual retreat in Jackson Hole, Wyoming, Powell said “the time has come” for interest rate policy to adjust.

That proclamation comes as inflation has fallen significantly from its pandemic-era peak in mid-2022. And the labor market, while still relatively healthy, has shown signs of weakness. Lowering rates would take some pressure off the US economy.

The Fed will likely choose between a 0.25 and 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 on Friday.

Lower interest rates are “generally positive for stocks,” said Marguerita Cheng, CFP and chief executive of Gaithersburg, Maryland-based Blue Ocean Global Wealth. Businesses may feel more comfortable expanding if borrowing costs are lower, for example, she said.

But uncertainty about the number of future rate cuts, as well as their size and pace, means investors should not make wholesale changes to their portfolios in a sudden 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.”

Lower interest rates generally mean investors can expect lower returns on their “safer” money, advisers said.

This would include relatively low-risk holdings, such as cash held in savings accounts, money market funds or certificates of deposit, and money in shorter-term bonds.

High interest rates have meant that investors can enjoy fairly high returns on these lower-risk holdings.

However, such yields are expected to fall as interest rates fall, advisers said. They generally recommend locking in high guaranteed cash rates now while they’re still available.

“It’s probably a good time for those considering buying CDs from the bank to lock in their higher rates for the next 12 months,” said Ted Jenkin, CFP and 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 investors don’t need for short-term expenses — in higher-paying fixed-income investments, such as longer-dated bonds, said Carolyn McClanahan, CFP and founder of Life Planning Partners of Jacksonville. Florida.

“We’re really aggressive about making sure customers understand the interest rate risk they’re taking on by staying in cash,” she said. “Too many people don’t think about it.”

“They will be crying in six months when interest rates are much lower,” she said.

Bond duration is a measure of a bond’s sensitivity to interest rate changes. Duration is expressed in years and includes the coupon, time to maturity, and yield paid over time.

Short-term bonds – with a term of perhaps a few years or less – generally offer lower yields but carry less risk.

Investors may need to increase their duration (and risk) to keep yields at the same level as the past two years or so, advisers said. The five- to 10-year term is probably OK for many investors right now, Sun said.

Advisers generally do not recommend changing stock and bond allocations.

But investors may want to allocate more future contributions to different types of stocks, Sun said.

For example, stocks of utilities and home improvement companies tend to perform better when interest rates fall, she said.

Asset classes like real estate investment trusts, preferred stocks and small-cap stocks tend to do well in such an environment, Jenkin said.