4 Steps To Take With Investments If Fed Cuts Rates, According To Financial Planners
Banks like Goldman Sachs and JP Morgan expect the Federal Reserve to cut interest rates during its September meeting, to reduce inflation following a historic increase over the last few years.
Investors tend to respond emotionally to significant market fluctuations, which can jeopardize long-term growth, particularly in retirement savings. What should they do instead? Financial planners weigh in.
1. Avoid Panic Selling During Short-Term Fluctuations
Ben Bakkum, a financial planner and senior investment strategist at Betterment, advises against panic selling during market downturns as overreacting to market fluctuation can hinder long-term growth potential.
“Ultimately, a lot of people miss out on returns they would have ended up with by being too reactive, ” says Bakkum. “They get spooked by something like policy changes and sell out of a diversified investment portfolio. Then, they miss out on the gains that would have come after that.”
Avoid drastic changes to your long-term portfolio based on short-term market predictions. He continues, “The majority of investment and retirement accounts are designed to withstand fluctuating market conditions and remain resilient during economic downturns.”
2. Decrease Risk Exposure Through Diversification
Pam Krueger, founder and CEO of Wealthramp, emphasized the importance of diversification and the need for a well-diversified portfolio to remain largely unaffected by short-term rate changes. “Diversity wins all battles. That means a diverse mix of everything so that you’re not beholden to any one thing, the economy.”
Bakkum says the same. “You want to be diversified so that you can rely on the expectation of the consistent, annualized returns generally provided by the market,” he says. As long as you have diverse holdings of stocks, bonds, and other securities, you shouldn’t experience any major setback in your portfolio, particularly during Fed cuts.
Stocks may perform poorly after rate cuts, but they also have the potential to increase as lower prices make borrowing more affordable for consumers and businesses. Investing for the long term provides time to recover from the market’s natural dips and valleys. Since you can’t predict the stock market, portfolio diversification is a crucial element in mitigating risk.
“You want to make sure you’ve got exposure to different areas of the market: mid-cap, small-cap, and international companies,” says Jaime Eckles, financial planner and wealth management partner with Plante Moran. “Decreasing rates should help smaller companies since they depend more on financing to spur growth and corporate profit.”
3. Revisit Your Investment Strategy
The Fed’s cuts create an opportunity for people to reevaluate their portfolios and consider shifting investments. “Generally, lower interest rates boost the economy as lending gets cheaper for consumers and businesses, ” says Eckles. “Revisit your overall investment strategy. Don’t restructure based on what the Fed will do and what the market will do. Instead, go back to your investment policy and understand why you’re there.”
Eckles encourages investors to have a balanced perspective of how the market might shift after interest rates are cut. “We’ve been calling for a recession for years. We’ve been talking about recessions for a very long time, and here we sit, and we have not seen a recession. So trying to move the portfolio around, trying to time recession or Fed rate cut, is a very hard thing to do. But this is a good time to revisit everything.”
Ensure your portfolio and current investment portfolio align with your goals and risk tolerance. You may want to consider talking with a financial advisor. “If you see yourself making an important life change that’s going to impact your finances in the next year or so, this is the time to sit down and have a fresh pair of eyes,” says Krueger.
4. Consider Reallocating Your Cash To Bonds
Cash held in high-yield savings accounts will be the most impacted by interest rate cuts. Cash positions have been attractive over the last few years, offering rates of 4.5% to 5% APY. However, as interest rates fall, the attractiveness of these cash investments declines.
“It’s easy to forget how much of an incredible wealth-generating engine the stock market is relative to something like a savings account or a money market mutual fund, ” says Bakkum. “If you’re worried about inflation eating away at the purchasing power of your retirement savings, the stock market is a great place to be over the long term. It’s riskier, but you’re compensated for that risk.”
The inverse relationship between bond prices and interest rates means that as rates fall, bond prices rise, providing another return component. “Bond ladders are useful if you have a distinct time horizon, want principal protection over that time period, and want to lock in an overall rate of return or yield,” says Bakkum.
He continues,”However, I wouldn’t recommend a bond ladder for retirement investors because the length of time you’re in retirement is uncertain, so a more diversified exposure in the fixed-income space where you could still benefit from price returns.”
Source: Business Insider