With the Fed poised to cut interest rates next week, the ripple effect will show up in certificates of deposit and high-yield savings accounts, which currently offer rates of more than 5%.
They aren’t likely to fall dramatically following a rate cut but rather ease back closer to 4% and linger above the inflation rate for at least the next year. So these accounts should still be your go-to for your emergency fund or cash set aside for short-term expenses.
That said, the Fed’s anticipated action offers an opportunity to make some money moves that take advantage of the downward tilt in interest rates.
“The projected cutting may pull the rug from under the high-yield savings rates,” Preston D. Cherry, founder and president of Concurrent Financial Planning, told Yahoo Finance. “Now might be the best time we've seen in a few years to swap cash in high-yield savings for long-term bonds to lock in a higher yield for income payments for lifestyle and retirement portfolios.”
Since 2022, when the Fed began to raise short-term interest rates, bank savings accounts have been a better place to park your cash than bonds. That’s set to change.
It's a good time to shift to bonds for those nearing retirement who are looking to rebalance their retirement savings amid stock market volatility.
The best way to earn a high total return from a bond or bond fund is to buy it when interest rates are high but about to come down, Cherry said.
If you buy bonds toward the end of a period when rates are rising, you can lock in high coupon yields and enjoy the increase in the market value of your bond once rates start to come down.
And if you’re a bond lover, you’re up. After more than a decade of dismal bond yields, the two-fold impact of high rates right now and falling inflation offers an opportunity for investment income. When interest rates move lower, bond prices will rise. (Interest rates and bond prices move in opposite directions.)
“Adding low-price and higher-yield long-term bonds at current levels could add total return diversification value to your bond and overall investment portfolio, which has not been the case in recent past rate-raising environments,” Cherry said.
This is a narrow opportunity, though, before rates start dipping and bond prices go up.
“If you have adequate liquidity and won’t need to tap the money at a moment's notice, then locking in bond yields now over a multiyear period can provide a more predictable income stream,” Greg McBride, chief financial analyst at Bankrate.com, told Yahoo Finance.
“As the Fed starts cutting interest rates, short-term yields will fall faster than long-term yields in the months ahead, so do this for the income rather than the expectation of capital gains,” he said.
Fidelity offers over 100,000 bonds, including US Treasury, corporate, and municipal bonds. Most have mid- to- high-quality credit ratings, but to me the sheer number of choices is mind-boggling. (Getty Images) ·(damircudic via Getty Images)
Laddering provides a 'more predictable income stream'
One way savers can pivot as rates head down is to set up a bond or CD ladder with staggered maturities, instead of investing all your funds in a single CD or bond with one set term length. This tactic can provide “a more predictable income stream while providing regular access to principal,” McBride said.
The bulk of my retirement holding is stocks and bonds mainly through broad index funds. How you divide up your savings and investments between stock and bonds, mutual funds and money market funds, or high-yield savings accounts is a balance that only you will know you’re comfortable with, based on your risk tolerance and how soon you need to tap the funds.
Many retirees want a more conservative asset mix as they age so they don’t face that uneasy feeling when the stock market is shaky. That’s why near-retirees and retirees, in particular, who haven't taken a gander at their asset allocations for a while should consider doing so.
How to put money in bonds for right now and retirement
Most 401(k) investors are in bond mutual funds for the fixed-income portion of their portfolios, which are highly diversified and usually invested in intermediate (five-year) high-quality government and corporate bonds.
Most of us aren’t researching and investing, for instance, in individual intermediate bonds. If you opt to do it yourself and choose individual bonds and hold them until they mature, you’ve got plenty to select from, of course. Fidelity offers over 100,000 bonds, including US Treasury, corporate, and municipal bonds. Most have mid- to- high-quality credit ratings, but to me the sheer number of choices is mind-boggling.
So I buy shares in a wide range of individual bonds via a bond mutual fund or ETF to add a bond ballast to my retirement accounts. The Vanguard Total Bond Market ETF, for example, is a diversified, one-stop shop comprising more than 11,000 “investment grade” bonds — including government, corporate, and international dollar-denominated bonds, as well as mortgage-backed and asset-backed securities — all with maturities of more than one year.
Right now, more than 60% of the Vanguard fund's total assets are in government bonds, and its year-to-date return is 4.94%.
As Vanguard notes, this fund “may be more appropriate for medium- or long-term goals where you’re looking for a reliable income stream and is appropriate for diversifying the risks of stocks in a portfolio.”
For shorter-term goals, staying ahead of rates falling is smart to lock in alluring rates for money you might need sooner rather than later.
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Cash has 'zero risk' of losing nominal value
The majority of financial advisers I spoke to didn’t suggest any knee-jerk actions ahead of the Fed meeting. In other words, don’t close your bank accounts.
“Inflation has certainly moderated, but in our opinion is not likely to be a further decline substantially,” said Peter J. Klein, chief investment officer and founder of ALINE Wealth.
If that’s the case, the Fed will not keep lowering interest rates but will hold them steady moving forward.
“Looking at the long arc of inflation history, one can see the changes … leading to sticky and persistent inflationary pressures. So, the notion that rates will come down substantially — and stay down — is not our base case,” Klein said.
That means that those savings you have in a federally insured, accessible bank account earning above the rate of inflation remain a good bet. That's especially the case for those nearing or in near retirement who plan to tap that money for living expenses and don’t want the worry that comes from price fluctuations in stocks and bonds.
“Cash is the only asset that an investor can deploy in a portfolio that has zero risk of losing its nominal value,” Klein added.