Why they are doing nothing to deal with lower interest rates

How should a retail investor handle Wednesday’s interest rate cut by the Federal Reserve and future rate cuts that appear to be on the horizon?

What I plan to do is nothing. Which may be what you should do too.

How can I say “do nothing” when the airwaves, print media and internet are full of advice and suggestions – and warnings – about how to handle the Fed’s rate cut?

Let me show you why my wife and I have no intention of doing anything about the rate cuts, which will reduce our interest income but not threaten our overall financial well-being. And why you might not want to do anything.

Here’s the deal. The Fed cut the federal funds rate to between 4.5% and 4.75% from the previous 5% to 5.25%. Fed Chairman Jerome Powell has indicated that the Fed plans at least one more rate cut this year.

29/08/24

The Fed only controls this short-term rate, but cutting it puts downward pressure on long-term rates as well. This is great, of course, for many of us, making it easier and cheaper to borrow. But it’s not great for savers. This is because the income they get from their savings will decrease.

Read more: Fed rate cut: What it means for bank accounts, CDs, loans and credit cards

We have significant cash holdings, which we hold in low-cost, high-quality money market funds. Our income from these funds, which have grown nicely in recent years, will decline. But that’s life.

Some people advise you to lock in the returns by switching your cash into long-term bonds or long-term certificates of deposit, whose interest rates are fixed and won’t fall due to Fed rate cuts.

However, there is a problem with doing this.

Locking in returns by buying long-term bonds or CDs makes your money illiquid. This exposes you to some long-term risks, such as having to sell at a loss if rates rise – which they will sooner or later, believe me – or if you need the money you’ve locked away in the long term.

Conversely, if you did what we did — put our excess cash into well-regarded, low-cost money market funds — your income will fall as the Fed’s interest rate cuts work their way through the financial system. But you still have liquidity, the ability to access your cash on demand, which is very important.

The one thing I won’t do – and neither should you – is put my money in a bank savings account, which usually pays returns that approach zero. Rates on those accounts are likely to drop a lot, if at all, because they’re already so low.

So if you have $3,000 or more in cash in a bank savings account but no money fund account, you’ll probably do well to open an account in a high-quality, low-cost fund.

The story continues

Certainly, unlike bank accounts, mutual funds are not backed by the Federal Deposit Insurance Corp. But there are plenty of high-quality, conservatively managed, low-cost funds. It’s a very competitive business with $6.68 trillion in assets, according to Crane Data. It is very unlikely to fail.

The most important thing to do now is to stay calm and remember that if you end up doing nothing to deal with lower interest rates, you’ll have plenty of company. Including me.

Update

Last July, I wrote a Yahoo Finance column titled, Warren Buffett turns 94 next month. Should Berkshire investors start worrying? I said Berkshire Hathaway shares have underperformed Vanguard’s S&P 500 index fund Admiral shares since my wife and I bought Berkshire shares in January 2016.

Since then, Berkshire has grown and outperformed the S&P 500.

As of Thursday’s market close, Berkshire is up 253% (15.6% annually) since I bought it. Over the same period, the index fund returned 242% (15.2% annually), according to Jeff DeMaso of Independent Vanguard Adviser.

Take out one for the Oracle of Omaha.

Yahoo Finance contributor Allan Sloan is a seven-time winner of the Loeb Award, business journalism’s highest honor.

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