Federal Reserve chair Jerome Powell recently gave a strong indication that the central bank is likely to start cutting interest rates, potentially in September. This would be the first rate cut in over four years and could have significant implications for investors. Financial advisors are recommending that most people, especially those well-diversified or invested in target-date funds, do not need to make major changes to their portfolios in response to potential rate cuts. These funds are managed by professionals who will make necessary adjustments behind the scenes.
For more hands-on investors, there are some adjustments to consider, particularly in cash, fixed income holdings, and potentially in the types of stocks in one’s portfolio. Lower interest rates are generally seen as positive for stocks, as they can lower borrowing costs for businesses and encourage expansion. However, investors should not make rash decisions based solely on Powell’s indications, as future rate cuts are uncertain and dependent on evolving economic data.
Falling interest rates are likely to result in lower returns on safer investments like cash, money market funds, and shorter-term bonds. Advisors recommend locking in high guaranteed rates on cash while they are still available. For excess cash that won’t be needed for short-term spending, parking it in higher-paying fixed income investments like longer-duration bonds may be beneficial. It’s important for investors to understand the interest rate risks they are taking by remaining in cash, as rates are expected to decline in the future.
Bond duration is a key factor in managing risk in fixed income investments. Short-duration bonds, with terms of a few years or less, provide lower returns but carry less risk. Investors may need to increase their duration to maintain yields at previous levels. Advisors suggest a duration of five to ten years may be appropriate for many investors at this time. While stock-bond allocations generally do not need tweaking, future contributions may be allocated to different types of stocks that tend to perform well when interest rates fall, such as utility, home improvement, real estate investment trusts, preferred stock, and small-cap stocks.
