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What Does the Rate Cut Mean for Your Investments?

Christine Benz discusses the implications of the Federal Reserve lowering interest rates for the first time in a decade.

Susan Dziubinski: Hi, I'm Susan Dziubinski for Morningstar.com. The Federal Reserve cut interest rates last week for the first time in a decade. Here with us today to talk about the implications for investors is Christine Benz. Christine is our director of personal finance.

Christine, thank you for joining us today.

Christine Benz: Susan, it's great to be here.

Dziubinski: Before we talk about implications, let's take a step back and talk about what the Fed's justification was for cutting rates, considering that employment looks pretty good and economic data overall looks pretty good.

Benz: Right. This one was a little bit controversial. In fact, we saw some second-guessing among commentators who suggested that the Fed really didn't need to be taking action at this juncture. The Fed's stated reason for lowering rates was that it was looking ahead with some concerns over some of the trade-war worries that have bubbled up in recent months, as well as taking a look at the global economic picture. We have seen slackening growth overseas. And that was another consideration, I think, in forming the Fed's decision to lower the interest rates, the fed-funds rate, by a quarter of a percentage point.

Dziubinski: And a rate cut is good news for investors who are carrying debt, right?

Benz: Well, it is, but it depends on what type of debt you have. So, if you have a fixed-rate mortgage, your standard 15- or 30-year mortgage, well, that's locked in, that's not obviously going to change when interest rates come down. On the other hand, if you have some sort of debt that is tied to the prime rate, and that would be credit card debt, or a home equity line of credit, for example, or maybe you have an adjustable-rate mortgage. Well, in that case, you will feel the effects of this, and it'll be for the better. So, this is good news for borrowers who have adjustable-rate forms of debt.

Dziubinski: Now, what about from a portfolio perspective? Specifically, if you're equity heavy, what does it mean for equities?

Benz: Well, one thing we've seen is that I think that this news that the Fed would begin adjusting rates downward has always has already been a catalyst for very strong equity market performance. So, through the end of July, for example, we've seen the S&P 500 up about 20% for the year to date. Tremendous rally, more than a year's worth of gains already in the year's first seven months. So, arguably, a lot of this was priced in. And we also see that in terms of some of the more-rate-sensitive equity types, they've performed especially well recently. So, real estate investment trusts, utilities. Things that we know investors sometimes use as proxy for fixed-income instruments, those have rallied in anticipation of the rate cut.

In terms of other investment types, fixed-income assets have also performed really well, again, ahead of the Fed actually announcing that it was going to lower interest rates. So, we have seen bonds rally. The Bloomberg Barclays Aggregate Index through the end of July is up about 6%. Again, a year's worth of gains for the bond market. So, it's been a great run for long-term assets. Cash yields, I would expect to see decline a little bit. There's a little bit of a lag effect typically in the wake of the Fed announcing a decision like that. But we have seen cash yields come up over the past few years. So, cash yields are certainly better than what they were in, say, 2016.

Dziubinski: Right. So, given all this, what should investors be thinking about or doing?

Benz: Well, given that the latest rate news I think has been catalyst or a partial catalyst for stocks and bonds' great recent gains, I think it's a great time to take a look at your total portfolio's risk exposures. And this is especially important for people who are getting close to or in retirement. A really logical place to go if you're a retiree who's in drawdown mode, and you're kind of looking for where you'll go for cash from your portfolio, in my mind, is harvesting some of your appreciated equity gains, using those monies to either add to your fixed-income securities or may be setting money aside for cash to meet your living expenses in the years ahead. I think that that's a terrific strategy. There's no telling whether stocks will continue to rally, but it's already been a great rally for stocks so far. So, I think you might as well harvest some of those gains.

Dziubinski: Christine, this is terrific perspective on what was a pretty big news story last week. Thank you for your time.

Benz: It's great to be here. Thank you, Susan.

Dziubinski: I'm Susan Dziubinski for Morningstar.com. Thanks for tuning in.