How will rate cuts affect your investments?
Vail, CO, Colorado
When the Federal Reserve Board cuts interest rates once, it makes the news. But when the Fed cuts rates twice within eight days, it’s a really big story.
So, when the Fed cut a key short-term interest rate by three-quarters of a point on Jan. 22, and followed this move by a half-point cut on Jan. 30, the world’s financial markets took notice. But as an individual investor, you probably wonder how these rate cuts might affect you.
Let’s consider your stocks first. As a (very) general rule, whenever the Fed cuts interest rates, stocks tend to benefit. That’s because low rates make it easier for businesses to borrow to expand their operations. At the same time, lower rates make it easier for consumers to borrow and spend.
Still, an interest rate cut ” or even two cuts ” may not affect all types of stocks in the same way or at the same time. For example, rate cuts may provide an immediate boost to the stocks of financial services companies, which depend heavily on short-term borrowing to finance their operations. And some types of consumer stocks may also do well following a rate cut.
However, interest rate cuts are just one of many factors that influence stock prices, so an interest rate cut alone isn’t a good reason to invest in a company or industry. Not all stocks are appropriate for your individual needs. Before adding any stock to your portfolio, make sure it’s suitable for your risk tolerance, your long-term goals and your need for diversification. (Keep in mind, though, that diversification, by itself cannot guarantee a profit or protect against a loss in a declining market.)
In the final analysis, you will almost always be better off by owning a mix of quality stocks and holding them for the long term, through all interest-rate environments, until either your needs change or the companies themselves undergo some transformation that you may not like.
Now let’s turn to bonds. When market interest rates are falling, the prices on your existing bonds should rise, because investors will be willing to pay you a “premium” for the higher rate on your bond. So, when the Fed aggressively cuts interest rates, you might assume that the value of your bonds will rise. However, some of your bonds ” specifically, bonds with maturities of 10 to 30 years ” are probably going to be affected more strongly by the rate cut than shorter-term bonds.
Should the Fed continue to lower interest rates, the value of existing long-term bonds could continue to increase. That said, predicting the direction of interest rates is extremely difficult. Thus, it may be preferable to be an “all-season” bond investor who doesn’t have to worry about interest rate movements at all, building a “bond ladder” consisting of bonds of varying maturities. That way, if rates are rising, you can reinvest the proceeds of your maturing short-term bonds in new issues, but if rates are falling, you’ll still have the higher rates of your long-term bonds working for you.
Clearly, the Federal Reserve’s interest-rate cuts can affect your investments. But if you’ve got a good, long-term strategy already in place, one that’s tailored to your needs and goals, you may find that it’s your investment decisions ” not the Fed’s ” that are most important of all.
Charlie Wick, Tina DeWitt, and Todd DeJong are financial advisers with Edward Jones Investments. They can be reached in Eagle at 328-4959, in Edwards at 926-1728, and in Avon at 845-1025.
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