How should a retail investor respond to Wednesday’s Federal Reserve rate cut and future rate cuts that appear to be on the horizon?
What I plan to do is nothing. What you should do too maybe.
How can I say “do nothing” when the airwaves, the print media, and the Internet are filled with 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 either.
Here’s the deal. The Fed has cut the federal funds rate from 5% to 5.25% to 4.5% to 4.75%. Fed Chairman Jerome Powell has made it clear that the Fed plans at least one more rate cut this year.
29-08-24
The Fed only controls these short-term rates, but by lowering them, it also pushes down long-term rates. Of course, that’s great for many of us, because it makes it easier and cheaper to borrow. But it’s not great for savers. That’s because the income they get on their savings will go down.
Read more: The Fed’s Rate Cut: What It Means for Bank Accounts, CDs, Loans and Credit Cards
We have significant cash positions, which we hold in low-cost, high-quality money market funds. Our income from those funds, which has grown quite a bit in recent years, is going to decline. But that’s life.
Some people advise you to lock in the returns by converting your money into long-term bonds or long-term certificates of deposit. The interest rates on these are fixed and will not go down if the Fed cuts rates.
There is a problem with this, however.
Locking in returns by buying long-term bonds or CDs makes your money illiquid. This exposes you to a number of long-term risks, such as having to sell at a loss if interest rates rise — which they will sooner or later, believe me — or if you need the money you’ve locked up for the long term.
If, on the other hand, you did what we did — put our excess cash into high-quality, low-cost money market funds — your income will decline as the Fed’s rate cuts work their way through the financial system. But you still have liquidity, the ability to access your money on demand, which is very important.
The one thing I won’t do — and you shouldn’t do either — is put my money in a bank savings account, which typically has returns close to zero. The interest on those accounts probably won’t go down much, if at all, because they’re already so low.
So if you have at least $3,000 in a savings account at the bank, but don’t have a savings account, your best bet is to open an account with a low-cost, high-quality fund.
Sure, unlike bank accounts, money funds aren’t covered by the Federal Deposit Insurance Corp. But there are plenty of high-quality, conservatively run, low-cost funds out there. It’s a highly competitive business, with $6.68 trillion in assets, according to Crane Data. They’re highly unlikely to fail.
The most important thing you can do now is stay calm and remember that if you ultimately do nothing to compensate for lower interest rates, you will have plenty of company. Including me.
Update
Last July, I wrote a column for Yahoo Finance headlined: Warren Buffett Turns 94 Next Month. Should Berkshire Investors Be Worried? I noted that Berkshire Hathaway stock had underperformed shares of Admiral, part of Vanguard’s S&P 500 index fund, since my wife and I bought Berkshire stock in January 2016.
Berkshire has since recovered and outperformed the S&P 500.
As of Thursday’s market close, Berkshire was up 253% (15.6% per year) since we bought it. Over the same period, the index fund has returned 242% (15.2% per year), according to Jeff DeMaso of the Independent Vanguard Adviser.
One point for the Oracle of Omaha.
Allan Sloan, a Yahoo Finance contributor, is a seven-time winner of the Loeb Award, the highest honor in business journalism.
Click here for the latest personal finance news to help you with investing, paying off debt, buying a home, retirement and more
Read the latest financial and business news from Yahoo Finance
