With the Federal Reserve target rate now down to 4.75% to 5%, a decrease of a half-point, many retirees may need to take a fresh look at their portfolios.
“A lower rate may impact an individual’s income generated by those investments and could require them to step outside their risk tolerance to grab more return and keep up with inflation,” said Faron Daugs, a certified financial planner and CEO of Harrison Wallace Financial Group in Libertyville, Illinois, in an email.
However, retirees shouldn’t expect to see the effects of a rate cut immediately.
“In the very short term, retirees and savers may not feel an immediate impact on their current fixed-income portfolios, as it may take time for the markets to adjust to the new normal,” said Emmanuel Eliason, a certified financial planner and CEO of Eliason Wealth Management in Centennial, Colorado, in an email.
He added that markets often price according to anticipated Fed movements.
“The bottom line for retirement savers and retirees is that they must plan and plan often to accommodate these possible scenarios,” Eliason said.
[What Is the Average Retirement Savings Balance by Age?]
How Do Lower Rates Affect Retirees?
Retirees’ portfolios are generally more conservative than investors’ in their accumulation years. That often means a higher allocation into fixed-income securities such as bonds.
“Since most retirees’ goal is to eliminate debt and increase their savings, lowering interest rates can be an unwelcome sight for those in retirement,” said John Vandergriff, owner of Blue Ridge Wealth Planners in Knoxville, Tennessee, in an email.
“This decreases their ability to have higher returns on risk-free assets and could cause those who go too conservative too quickly to have a higher-than-normal risk with inflation,” he added.
It’s not just bonds and stocks that will be affected by a rate cut.
Some retirees opt for certificates of deposit and money market accounts, which don’t offer growth but are a way to protect capital and generate some income.
“Retirees generally will live on interest earned from CDs and bonds,” said Jason Bernat, president and CEO of American Financial Services in Boardman, Ohio, in an email.
A Federal Reserve rate cut results in lower interest rates on CDs and lower yields on newly issued bonds.
“Also, other fixed-income products like annuities will also offer much lower rates,” Bernat said, adding that rates on savings accounts and money market funds will also decline.
[Ask a Financial Pro: My Retirement Savings Are Up. Should I Retire This Year?]
How Do Lower Rates Affect Fixed-Income Investments?
When interest rates drop, previously issued bonds typically increase in value because their higher interest payments become more attractive than newly issued bonds with lower rates.
“Typically, bonds will make money as interest rates drop. If you have a bond that pays 5% and everyone else is paying 4%, that increases the value of the bond that you hold,”Vandergriff said.
That’s good news for holders of existing bonds, but makes newly issued bonds less appealing.
“Lower rates from the Fed drive all the fixed-income markets,” said Eric Kelley, chief investment officer at UMB Bank in Kansas City, Missouri, in an email.
Kelley added that Treasury rates had already fallen in recent months in anticipation of Fed rate cuts.
“Municipal bonds, CDs, savings bonds and virtually all other types of fixed-income instruments have experienced falling yields lately and will likely fall a bit further in coming months,” he said.
What’s the Impact on Stocks?
When interest rates fall, stocks tend to perform well because borrowing costs decrease. That can boost corporate profits and encourage business expansion.
Additionally, lower yields on bonds make stocks more attractive to investors seeking higher returns, potentially sending stock prices higher.
“The equity markets have already factored in the expected lower interest rates from the Federal Reserve,” said Steve Rick, chief economist at TruStage in Madison, Wisconsin, in an email.
Rick noted that the S&P 500 has been trading at new highs, with the Fed expected to lower rates several times in the next two years.
Many sectors tend to benefit from lower rates. One fairly obvious example is real estate, which gets a boost from lower rates. Dividend-paying sectors like consumer staples and utilities can benefit as income-seeking investors turn to those instead of bonds.
Even a growth industry like technology tends to rise as mid-caps and companies with heavy debt see borrowing costs decrease. That’s not as relevant for tech giants like Apple (ticker: AAPL) or Microsoft (ticker: MSFT) that rely on cash more than debt, but across the board, lower rates make future cash flows more valuable. And that increases investor interest in growth-focused techs.
[How to Protect Your Retirement Savings in an Election Year]
Should Retirees Make Portfolio Changes Now?
While market timing in response to events can be risky if investors are going on hunches, a rate cut may present an opportunity to rebalance one’s asset allocation.
“Now is a good time for retirement savers and retirees to assess and see if they have the right types of bonds or allocation mixes,” Daugs said.
He added that retirees may also want to consider investment opportunities that would yield a return, but he suggested consulting with a financial advisor who can provide personalized guidance.
An investment mix tailored to any individual’s or couple’s unique goals is, in most cases, more suitable than chasing returns or hiding out in cash.
“The long-term needs of a retiree should not change based on interest rate decisions by the Federal Reserve,” Vandergriff said.
“Are there opportunities to shift and benefit? Sure, but that should be in conjunction with a financial plan that uncovers what the retiree is trying to accomplish. Too many times retirees look for short-term opportunities to the detriment of their long-term plan,” he added.
More from U.S. News
What Will the Social Security COLA Raise Be for 2025?
Frequently Asked Social Security Benefit Questions
How Raising the Retirement Age Could Help or Hurt Seniors
What Do Lower Interest Rates Mean for Retirees? originally appeared on usnews.com
Update 09/18/24: This story was published at an earlier date and has been updated with new information.
