Ask an advisor: How should I invest if the Fed starts lowering interest rates?

Ask an advisor: How should I invest if interest rates come down?

September 21, 2023 4:23 PM

Someday interest rates will come down again, leading some investments to rise and others to fall.

Welcome back to "Ask an Advisor," the advice column where real financial professionals answer questions from real people. The topic can be anything in the world of finance, from retirement to taxes to wealth management — or even advice on advising.

This week, for the second time, we're taking a different approach than usual: The question comes from yours truly, FP reporter Nathan Place.

My question is how to adapt when something happens that right now may seem unimaginable: Interest rates start coming down.

Since March 2022, the Federal Reserve has raised the federal funds rate 11 times in its battle against inflation. And for the most part, it's been working: The 12-month change in the consumer price index was at a historic 9.1% in June 2022. One year later, it was down to 3% — though since then, it's ticked back up to 3.7%.

On Wednesday, the Fed declined to raise rates once again, instead taking a pause. That move is open to interpretation, but it's a reminder that this too shall pass — one day, whether it's months or years from now, the Fed will start bringing rates down.

My question is, what do we do then? Like many of our readers, I turned to the experts for help. Here's what I wrote:

Dear advisors,

What should investors do if interest rates come down? Yesterday the Fed took a pause on raising the federal funds rate, and presumably one day, when inflation is low enough, it will lower them.

At that point, how should people change their investments? Which assets will especially benefit from monetary easing? Which assets will not? And if inflation is lower as well, how does that change the picture?

Sincerely,

Nathan "Musing in Manhattan" Place

And here's what financial advisors wrote back:

Stock up

Greg Vojtanek, certified financial planner and owner of

Fade In Financial

in Burbank, California

When interest rates are lowered I tend to think about two types of investments: stocks and Treasuries.

Treasuries become less attractive because their returns are so low. Current rates on Treasuries are north of 5.5%, and many people are okay with that. But when they drop to 2% or lower, then most investors start to look elsewhere.

That's when the stock market tends to rise. Now there's a flood of money transferring out of Treasuries and into the markets. Savvy investors can realize this and take advantage of markets rising while interest rates fall.

Don't forget real estate

Tom Balcom, CFP and founder of

1650 Wealth Management

in Lauderdale-by-the-Sea, Florida

While no one knows the future, I am anticipating that rates will stay steady for the next six months. With that being said, investors should begin to position themselves for lower short-term rates at some point next year. This might consist of extending duration in their bond portfolios by selling short-term bonds and buying longer-term bonds. The assumption is that the yield curve will change from inverted to normal and that investors will benefit from longer-duration bonds.

Real estate is one asset class that will directly benefit from lower interest rates as the cost of borrowing declines. This will flow to the bottom line of REITs (real estate investment trusts) and their investors. Technology stocks also would benefit from monetary easing, as they are known as long-duration assets.

Typically, banks will not benefit from declining interest rates. They will earn less on their short-term investments.

Lower inflation is a positive for the consumer and the overall economy, as goods and services will cost less and provide individuals with more disposable income.

Tread carefully

Nicholas Bunio, CFP at

Retirement Wealth Advisors

in Downingtown, Pennsylvania

If rates do indeed fall, I'd say stocks in general and bonds will do well, especially bond funds (due to the inverse relationship of rates). I think long-term bonds would do better, too, due to duration and falling rates.

Of course, very short-term bonds probably won't do well. The same goes for cash and CDs, since cash will capture these falling rates. One thing to also be aware of is annuities like fixed-rate and MYGAs (multiyear guaranteed annuities) will start to lower rates.

FIAs (fixed indexed annuities) could see lower crediting rates, but as stock indexes do better, that can offset lower crediting rates. I'd also feel that if rates fall, it's probably due to lower inflation where commodities also see prices fall. So commodities would be something to be cautious about.

Don't count on a soft landing

Jeremy Bohne, founder of

Paceline Wealth Management

in Boston

Declining interest rates are not a question of "if," but of "when" — and "how" to prepare for this adjustment. Rates may climb a bit higher in the near term, but the net result is likely for rates to be meaningfully lower at some point(s) over the next one or several years.

Candidly, the idea of a soft landing seems a bit naive given that in the past, inflation has never declined from its current level (let alone the recent peak) back down to 2% without causing a recession.

The most obvious change for investors is that when rates decline, deposit rates on bank accounts will drop. However, banks are already wary of losing deposits, given the bank failures that led depositors to suddenly flee troubled banks. My feeling is that banks will be faced with the choice of taking a hit to profits (not fully dropping deposit rates), or taking the risk of depositor withdrawals. The former of the two is the safer option.

For consumers, preparing for an eventual rate decline means that loading up on short-term bonds, which currently pay the most interest, may not be the best idea given that they won't experience any upside in price compared to intermediate or long-term bonds.

High interest rates also tend to favor lower-priced value stocks over growth stocks, while lower interest rates benefit growth stocks. The complicating factor here, though, is that if rates are coming down, it's probably because inflation has cooled and the economy will have, too, so growth stocks may be dented as well.

That's why growth investors are enamored with the goldilocks scenario of a soft landing. It tells them that there is upside in growth stocks because rates are going down, yet they don't face the risks that often follow growth stocks in a cyclical downturn.

Value investors, and the bond market, on the other hand, are telling a more traditional story that rates will come down because the economy has begun to suffer, which is the normal historical precedent.