In September, the Fed lowered interest rates for the first time since 2020, and they continued to cut rates at the November meeting. This move followed a slowdown in inflation and some softening in the labor market.
Lower interest rates have historically produced fairly predictable outcomes for the economy and individual investors. However, people who are nearing or enjoying retirement are in a unique position that doesn’t always align with the general population. That’s why it’s important to study how lower interest rates impact your retirement plan.
Lower Interest Rates Generally Mean Lower Bond Yields
Bonds are an important part of many retirement plans because they provide safety, diversification, and reliable income. Unfortunately, lower interest rates can impact the amount of income retirees earn from bonds.
Because bonds are debt instruments, their yields are influenced by the Fed Funds Rate. As this rate falls, yields for newly issued bonds tend to follow. If you buy these bonds or hold bond mutual funds, your income could decline due to the lower yields.
Fortunately, there are also positive impacts of lower interest rates on bonds. The resale value of existing bonds rises when newly issued bonds have lower yields. Therefore, you may be able to make a profit when selling existing bonds or bond mutual funds on the secondary market.
Lower Interest Rates Tend to Spur the Economy and Stock Prices
Stocks are also influenced by the Fed Funds Rate – though the relationship is more indirect than with bonds. There are three main ways that interest rates influence stocks including business growth, economic growth, and valuation calculations.
Lower interest rates make it cheaper for businesses to invest in growth activities. This dynamic often leads to stronger business performance and higher stock prices.
Interest rate cuts also make it cheaper for individuals and businesses to borrow money to purchase new products. Therefore, the economy generally strengthens during periods of low interest rates. Higher spending also translates to higher sales for businesses, which encourage stock price growth.
Additionally, many stocks are valued using a formula that relies on the risk-free rate. This rate is influenced by the prevailing interest rates and as it falls, some stocks – particularly those with high prospects for growth – become more valuable.
Because of the relationship between interest rates and the stock market, you are generally able to sell the stocks in your portfolio at higher values – leading to profits. As companies grow, you could also earn higher dividends from the stocks you own.
Retirees Could See Lower Expenses When Interest Rates Fall
One of the most well-known effects of lower interest rates is lower costs for loans. If you are still paying for your home, car, or other loan during retirement, these lower rates could allow you to refinance at more favorable terms.
By refinancing high-interest loans, you can lower your monthly payments and have more income to devote to saving for retirement or funding your lifestyle if you are already retired. You may also gain the opportunity to stretch your loans over a lengthier timeframe, giving you even more cash available each month.
The cost of your loans is one factor that can influence your Required Rate of Return™ – the amount of income investments need to generate to cover your expenses. This figure could change if you choose to refinance, which can significantly impact your retirement needs and how you allocate your portfolio.
The Overall Impact of Lower Rates and How You Can Adjust Your Retirement Plan
Overall, lower interest rates can cause a decline in bond income coupled with higher prices for the securities in your portfolio. You may also be able to lower your monthly payments by refinancing high-interest loans, which could help to offset the lower income from your bonds. The degree to which each of these factors influences your retirement plan will depend on your unique situation.
An experienced financial advisor can help you determine how these factors impact your retirement plan. The right advisor will also help you determine if you need to make any adjustments to your portfolio to take advantage of lower interest rates.
Meld Can Help You Prepare for Lower Interest Rates
At Meld Financial, our team will help you determine how interest rate cuts might impact your current retirement plan and whether you need to make any changes. We have spent three decades helping clients navigate changing economic situations, and we look forward to the opportunity to help you as well.
Our comprehensive wealth management plan, Financial Fingerprint®, brings together the most important aspects of your financial life including investments and expenses. Best of all, this plan is adaptable to meet changing needs and economic conditions. To learn more about Financial Fingerprint® or to discuss your personal situation, contact a member of our team today.
