How should retail investors handle Wednesday’s interest rate cut by the Federal Reserve and expected rate cuts in the near future?
What I’m going to do is do nothing, and maybe you should too.
How can we say “do nothing” when the radio, print media and the Internet are awash with advice, suggestions and warnings on how to respond to the Fed’s rate cuts?
Because lowering interest rates would reduce our interest income but would not threaten our overall financial position, let me explain why my wife and I have no intention of doing anything about lowering interest rates, and why you probably don’t want to do anything either.
Here’s the problem: The Fed just cut the federal funds rate to 4.5% to 4.75% from 5% to 5.25% and Fed Chairman Jerome Powell has said the central bank plans to cut rates at least one more time this year.
August 29, 2024
The Fed only controls these short-term interest rates, so lowering them puts downward pressure on longer-term interest rates as well. Of course, this is a good thing for many people because it makes borrowing easier and cheaper. But it’s not good for savers, because it reduces the income they can earn on their savings.
Read more: Federal Reserve Rate Cut: How it affects bank accounts, CDs, loans and credit cards
We have a lot of cash sitting around, invested in low-cost, high-quality money market funds. The income from these funds, which has grown steadily over the past few years, will likely decline. But that’s life.
Some people recommend locking in a yield by switching your cash to long-term bonds or certificates of deposit, which have fixed interest rates that won’t fall as the Fed cuts rates.
But there are problems with doing so.
When you buy long-term bonds or CDs to lock in a yield, you make your money illiquid, which exposes you to long-term risk, such as having to sell at a loss if interest rates rise (and they will rise sooner or later, trust me) or if you need the cash you locked in for the long term.
Financial markets man? Federal Reserve Chairman Jerome Powell (Photo: Chip Somodevilla/Getty Images) (Chip Somodevilla via Getty Images)
In contrast, if you do as we did – invest your excess cash in a reputable, low-cost money market fund – your income will likely fall as the Fed’s rate cuts ripple through the financial system, but your liquidity will still be there, and the ability to withdraw cash as needed will be crucial.
What I would never do, and what you shouldn’t do either, is put my money in a savings account at a bank. Savings account interest rates are usually close to zero. Savings account interest rates are already so low that they’re unlikely to go down.
So, if you have more than $3,000 in cash in a savings account at a bank but don’t have a money fund account, it would be a good idea to open an account in a low-cost, high-quality fund.
The story continues
True, unlike bank accounts, money funds aren’t insured by the Federal Deposit Insurance Corp. But there are plenty of high-quality, conservatively run, low-cost funds out there. Money funds are a highly competitive business, with $6.68 trillion in assets, according to Crane Data, and the chances of one going bust are slim.
The most important thing for you to do right now is to stay calm and remember that if we don’t do anything to address the decline in interest rates, many of us will find ourselves in the same situation – myself included.
Never doubt it WB: Warren Buffett in Omaha, Nebraska. (Photo: AP/Nattie Harnick, Archivo) (Associated Press)
update
Last July, I wrote a Yahoo Finance column headlined “Warren Buffett turns 94 next month. Should Berkshire investors start to worry?” I noted that since my wife and I bought Berkshire shares in January 2016, Berkshire Hathaway shares have underperformed Admiral shares in the Vanguard S&P 500 index fund.
Berkshire has since rallied, outperforming the S&P 500.
As of the market’s close on Thursday, Berkshire shares had risen 253% since the purchase, or 15.6% annualized. Over the same period, the index fund gained 242%, or 15.2%, according to Jeff DeMaso of Independent Vanguard Advisors.
The Sage of Omaha scores one point.
Yahoo Finance contributor Alan Sloan is a seven-time recipient of the Loeb Award, business journalism’s highest honor.
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