How to Prepare for Falling Interest Rates: A Guide for Savers and Investors

As the economy cools down and inflation moderates, the Federal Reserve's next moves are once again in the spotlight. After an extended period of relatively high interest rates, a looming shift in monetary policy stands to have major ramifications for consumers, savers, and investors alike.

Federal Reserve officials have signaled that they could begin cutting interest rates later this year, representing a critical turning point in the economic landscape. This shift brings both potential risks and rewards, highlighting the importance for individuals to have a well-thought-out financial plan to navigate the changing environment.

Falling Interest Rates & Your Financial Plan

Falling interest rates can significantly influence various aspects of your financial plan, from purchasing a home and saving for the future to establishing a rainy-day fund. By understanding these effects, you can take steps to protect your financial health while continuing to work toward longer-term goals.

#1: Reduced Earnings on Savings Accounts

When the Federal Reserve lowers interest rates, banks and other financial institutions typically follow suit by adjusting the rates they offer on savings accounts.

The recent period of high interest rates has allowed many savers to benefit from above-average yields on their savings accounts, with some high-yield accounts offering annual percentage yields (APYs) of 5% or more as of June 2024. However, as interest rates fall, banks will likely reduce the rates they pay on savings and other deposit accounts. This reduction means savers will earn less on their cash deposits, slowing the growth of their savings.

#2: Effect on Bond and Stock Prices

Interest rate fluctuations can have a substantial impact on both bond and stock prices, affecting their relative attractiveness and value. For investors nearing retirement or working toward specific financial goals, it’s crucial to understand how falling interest rates influence different asset classes.

First, bond prices typically move in the opposite direction of interest rates. When rates fall, bond prices increase, potentially benefiting bond investors through higher market values. However, falling rates also introduce reinvestment risk, as investors with maturing bonds or those receiving coupon payments may have to reinvest the proceeds at lower rates of return.

Conversely, lower interest rates often result in reduced borrowing costs for companies, which can boost corporate profits. As investors seek higher returns, this potential increase in profitability may lead them to prefer stocks over bonds, although results can vary depending on the 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 the average interest rate on a 30-year fixed mortgage exceeding 7% as of June 2024, many potential homebuyers have had difficulty securing affordable financing, leading them to postpone or adjust their buying plans. As interest rates decline, better financing options may become available for those previously out of luck.

For those who did take out loans during this period, rising rates may have pushed their monthly payments to uncomfortably high levels. Falling interest rates could ease this burden, unlocking opportunities to refinance existing loans and make borrowing more affordable again.

#4: Real Estate Market Implications

The recent jump in interest rates has made it more challenging for potential homebuyers to secure affordable loans, decreasing demand for real estate and slowing property sales. However, as interest rates start to fall, the real estate market could experience a resurgence, presenting new opportunities for both buyers and sellers.

When borrowing costs go down, more people tend to enter the real estate market, which can lead to an increase in property values. This is potentially good news for sellers who may have had difficulty finding buyers when mortgage rates were high.

Additionally, falling interest rates might encourage some homeowners to put their properties on the market, particularly those who have been hesitant to give up their lower, locked-in mortgage rates. According to Fannie Mae’s 2023 National Housing Survey®, this has been the main reason why homeowners have delayed moving. If more homes become available for sale, it could help balance the market and make prices more manageable for buyers.

#5: Falling Interest Rates and Retirement Goals

Falling interest rates can present a unique challenge for retirees and those approaching retirement who often depend on fixed-income investments, such as bonds and Certificates of Deposit (CDs), for a significant portion of their income.

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

Preparing for Falling Interest Rates

To minimize the risks and seize potential opportunities in a falling interest rate environment, consider implementing the following strategies:

#1: Explore Other Uses for Your Excess Cash

If you've been holding cash to take advantage of higher interest rates, it may be time to explore alternative investment opportunities. Despite carrying more risk than savings accounts, investing in stocks and bonds could offer greater growth potential, allowing your money to work harder for you.

Alternatively, falling interest rates may present an opportunity to use your cash to pay down high-interest debt or make a significant purchase. By reducing your debt burden or acquiring assets at favorable prices, you can strengthen your overall financial position.

#2: Diversify Your Portfolio

As interest rates fall, it becomes increasingly important to diversify your investment portfolio. Diversification is a key investment strategy that involves allocating your money across different asset classes, such as stocks, bonds, and real estate.

By spreading your investments, you can minimize the impact of underperformance in any single asset class. For instance, if falling interest rates make bonds less attractive due to lower yields, a simultaneous rise in stock values may help to offset potential losses. This approach can smooth out returns and provide a measure of protection against the negative effects of any single economic event.

#3: Look for Opportunities to Lower Your Cost of Debt

If you have existing debts, such as a mortgage or student loans, refinancing at a lower interest rate could reduce your monthly payments and enable you to pay less interest over the life of the loan. Just be sure to weigh the projected savings from refinancing against the associated costs, such as closing fees and appraisal expenses, to ensure the process is worthwhile.

Falling interest rates may also provide an opportunity to consolidate your debts or accelerate your loan repayment plan. By consolidating high-interest debts into a single, lower-interest loan, you can simplify your payment schedule and reduce your overall interest expense.

#4: Evaluate Your Real Estate Options

For potential homebuyers, declining interest rates can be a boon, as lower borrowing costs lead to more affordable mortgage rates. This can substantially reduce the total amount of interest you pay over the life of your mortgage and increase your purchasing power, potentially allowing you to afford a more expensive home or a more desirable location.

Meanwhile, sellers may find that falling interest rates create a more favorable market for listing their properties. As borrowing costs decrease, more buyers may enter the market, leading to increased demand for homes. This surge in demand can result in faster sales and potentially higher selling prices, as competition among buyers intensifies.

#5: Revisit Your Retirement Plan

For those nearing or already in retirement, falling interest rates can have significant implications for your income strategy. It's essential to reassess your retirement plan to ensure it remains aligned with your goals and can withstand the potential challenges posed by lower rates.

This may mean postponing Social Security benefits to secure larger payouts later or revisiting 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. Be sure to consult with an experienced financial advisor, who can help you determine the best approach for your financial objectives.

Prepare for Falling Interest Rates with Kukui Tree’s Guidance

Preparing for falling interest rates isn’t just about safeguarding your financial well-being; it’s also about recognizing and seizing the opportunities that such changes may present. By proactively positioning yourself to take advantage of these opportunities, you can enhance your financial stability and navigate the shifting economic landscape with confidence.

At Kukui Tree Capital Management, our mission is to support our clients at every stage of their financial journey, empowering them to achieve financial prosperity through comprehensive, tax-aware wealth management. If you’re looking for personalized financial planning and investment guidance, we’re here to help. Contact us today to schedule a “Get Acquainted” Meeting and see if we’re the right fit for you.