Preparing for Falling Interest Rates: A Guide for Savers and Investors

As the economy slows and inflation eases to more controllable levels, the spotlight turns back to the Federal Reserve. After an extended period of interest rate hikes, a shift in monetary policy could significantly impact consumers, savers, and investors. The Fed has indicated it could cut rates as soon as this year, marking a pivotal change in the economic environment. Falling interest rates present both challenges and opportunities, underscoring the need for a sound personal financial plan.

How Falling Interest Rates Impact Financial Planning

Falling interest rates have a broad impact on financial planning, affecting everything from buying a home and saving for retirement to building an emergency fund. By understanding these effects, you can adjust your financial plan to safeguard your financial well-being while staying on track toward your long-term goals.

#1: Reduced Earnings on Savings Accounts

Banks and other financial institutions typically align the interest rates on savings accounts with the broader interest rate environment, which the Fed’s policy rates influence.

Due to elevated interest rates, recent yields on savings accounts have exceeded their historical norms, benefiting many savers. For instance, some high-yield savings accounts are currently offering an annual percentage yield (APY) of 5% or more.

However, when interest rates drop, banks typically reduce the rates on savings and other deposit accounts. As a result, savers earn less on their cash deposits, causing their savings to grow at a slower pace.

In some cases, savers might move their cash from savings accounts to higher-risk investments for potentially higher returns. Others might opt to spend their money on significant purchases or delayed expenses as the appeal of keeping cash in savings accounts wanes.

#2: Effect on Bond Prices and Stock Prices

The ebb and flow of interest rates can significantly affect both bond and stock prices, impacting their relative appeal and value. For investors, particularly those close to retirement or working toward specific financial goals, understanding how falling interest rates influence various asset classes is essential.

Generally, bond prices move inversely to interest rates. That means when rates drop, bond prices rise, which could benefit bond investors through increased market value. Yet, declining rates also introduce reinvestment risk, as those with maturing bonds or receiving coupon payments might be forced to reinvest the proceeds at lower rates of return.

On the flip side, reduced rates often mean lower borrowing costs for businesses, which can enhance corporate profits. As investors seek higher returns, this potential increase in profitability could lead them to favor stocks over bonds, although results may vary by sector.

#3: Lower Borrowing Costs

The recent high interest rate environment has made borrowing, especially for significant purchases like homes, quite challenging for many consumers. With mortgage rates peaking near 8% in October 2023, many potential homebuyers have found it difficult to secure affordable financing, leading them to postpone or adjust their buying plans.

For those who have taken out loans during this period, increasing rates may have pushed the resulting monthly payments to uncomfortably high levels. Fortunately, falling interest rates could lighten the load, making borrowing more affordable again.

Indeed, better financing options may become available for those previously out of luck. Meanwhile, borrowers who are already paying off a loan or mortgage might find opportunities to refinance, potentially lowering their interest rates and monthly payments.

#4: Real Estate Market Implications

The recent surge in interest rates has significantly impacted the housing market, making it harder for buyers to afford loans, dampening overall demand, and slowing property sales. However, falling interest rates could breathe new life into the real estate market, unlocking opportunities that once seemed out of reach.

As borrowing costs decrease, real estate demand tends to increase, potentially driving up property values. This scenario would be particularly advantageous for sellers who previously struggled to find buyers in a market stifled by high mortgage rates.

At the same time, falling interest rates could encourage more homeowners to consider selling, especially those who have chosen to stay put to maintain lower, locked-in mortgage rates. In fact, this is the top reason homeowners have put off moving, according to Fannie Mae’s 2023 National Housing Survey®. A potential increase in supply could benefit prospective homebuyers if it causes home prices to moderate.

#5: Falling Interest Rates and Retirement Goals

For those in or nearing retirement, who often rely on fixed-income investments like bonds and Certificates of Deposit (CDs) for a substantial portion of their income, falling interest rates introduce a distinct challenge. These investments, despite offering more stability and predictability than stocks, also tend to be influenced more directly by interest rate changes.

As interest rates decrease, the yields on newly issued fixed-income securities also fall. Thus, when retirees reinvest their money or contribute new cash to their investment portfolios, their return potential may fall, possibly leading to a drop in anticipated retirement income.

How to Prepare for Falling Interest Rates

The following strategies can help you mitigate the risks associated with falling interest rates and take advantage of potential opportunities.

#1: Consider How You’re Using Your Cash

As yields on savings accounts and other savings vehicles decrease in response to falling interest rates, it’s wise to consider reallocating cash to other investment opportunities or uses that may offer a more favorable risk-reward trade-off.

For instance, if you’ve been holding cash to benefit from rising or elevated interest rates, you might want to consider exploring other avenues for your funds. Investing in stocks and bonds, despite their higher risk profiles compared to savings accounts, could provide greater potential for growth, allowing your money to increase more rapidly.

On the other hand, with the decline in savings account yields, it may be wise to use your cash for reducing high-interest debt or making a major purchase. It’s critical to weigh these options against your financial goals and how much risk you’re comfortable taking, as making informed decisions is key to maintaining financial stability.

#2: Diversify Your Portfolio

As interest rates decline, the importance of diversifying your investment portfolio intensifies. Diversification is a fundamental investment strategy that involves spreading your investments across various asset classes, such as stocks, bonds, and real estate.

If one asset class underperforms due to falling interest rates, another may outperform, helping to offset potential losses. For example, while bonds might become less attractive in terms of yield, equities may see an appreciation in value, balancing your investment outcomes.

A well-diversified portfolio can help ensure that the impact of rate changes is more evenly distributed across your investments. This approach can help smooth out returns and provide a degree of protection against the adverse effects of any single economic event.

#3: Lower Your Cost of Debt, If Possible

For those carrying debt, falling interest rates may present an opportunity to lower your borrowing costs.

For those with current loans, refinancing at a reduced interest rate could lead to lower monthly payments and minimize the total interest you pay over the duration of the loan. However, it’s crucial to assess the refinancing costs to confirm that the anticipated savings exceed these expenses.

Additionally, decreasing interest rates offer a chance to consolidate debt or expedite your loan repayment plan. Streamlining your payments and reducing your overall interest expense can unlock extra funds for other financial goals.

#4: Evaluate Potential Real Estate Opportunities

Falling interest rates can significantly influence the dynamics of the housing market. For those looking to buy or sell real estate, this shift can present both challenges and opportunities.

Buyers are in a position to benefit from lower borrowing costs, securing more manageable mortgage rates. This can notably reduce the overall interest you pay over the mortgage’s term and increase your capacity to afford a home.

Conversely, sellers might see an uptick in demand as interest rates fall. Choosing to list your home during a period of falling rates could lead to a quicker sale and potentially higher selling price due to increased competition among buyers.

It’s important to stay informed of trends in interest rates and overall market conditions to effectively adapt to these changes. In addition, consider consulting with a trusted financial advisor, who can help you make informed decisions that align with your broader financial objectives.

#5: Revisit Your Retirement Plan

If you’re approaching or in retirement, it’s crucial to reassess your income strategy to ensure it aligns with the potential for a lower interest rate environment. This may mean postponing Social Security benefits to secure larger payouts later or reevaluating your withdrawal rates to maintain your financial stability.

Expanding your investment portfolio to include assets like dividend-paying stocks or real estate investment trusts (REITs) may also be beneficial. Despite their higher risk compared to some bonds, these options may offer the potential for higher yields and returns as interest rates fall.

Milestone Asset Management Group Can Help You Prepare for Falling Interest Rates

Preparing for falling interest rates isn’t just about protecting your financial well-being. It’s also about proactively positioning yourself to capitalize on the opportunities that future changes may bring. A sound financial plan can help you navigate a shifting economic environment with confidence.

Milestone Asset Management Group is here to help. Contact us to discover how our comprehensive financial planning approach can help you achieve your goals and prepare you for the challenges and opportunities that lie ahead.