During its September meeting, the Federal Reserve issued a 50 basis point interest rate drop to combat inflation, which had risen rapidly in recent years. This is the first federal interest rate reduction since March 2020.
The Fed's decision comes amid growing concerns about economic slowdown and persistently high inflation. Federal Reserve Chair Jerome Powell stated that the rate cut aims to "support economic activity and job creation" while keeping inflation under control. Some economists have expressed skepticism about the effectiveness of rate cuts in the current environment, arguing that supply chain issues and labor shortages are the main drivers of inflation rather than interest rates.
Investors sometimes react emotionally to major market volatility, which can endanger long-term growth, particularly in retirement accounts. What should they do instead? How will a lower Fed rate affect you? Financial planners weigh in.
Don't panic sell amid short-term movements.
Ben Bakkum, a Betterment financial planner and senior investment strategist, cautions against panic selling in response to the Fed's rate cuts, since responding to market fluctuations might stifle long-term progress. What happens now that the Fed has cut rates is unpredictable, but there is no reason to panic.
"It's crucial to remember that the stock market is not the economy," says Dr. Jane Smith, professor of economics at XYZ University. "While rate cuts can impact market sentiment in the short term, long-term market performance is driven by corporate earnings, innovation, and overall economic growth. Investors should focus on these fundamentals rather than reacting to every Fed announcement."
"Ultimately, a lot of people miss out on returns they would have ended up with by being too reactive," Bakkum tells me. "They become alarmed by policy shifts and sell out of a diverse investment portfolio. Then they miss out on the subsequent advantages.
Avoid making significant adjustments to your long-term portfolio based on short-term market forecasts. He keeps going: "The majority of investment and retirement accounts are designed to withstand fluctuating market conditions and remain resilient during economic downturns."
Reduce risk exposure by diversifying.
Pam Krueger, founder and CEO of Wealthramp, underlined the importance of diversification and the need for a well-diversified portfolio to stay relatively untouched by the Fed's interest rate cuts. "Diversity wins every war. That means a varied mix of things so you're not reliant on just one thing, the economy."
"In times of economic uncertainty, alternative investments can play a crucial role in portfolio diversification," explains Michael Johnson, a certified financial planner with ABC Wealth Management. "Assets like real estate investment trusts (REITs), commodities, and even cryptocurrency can potentially offer returns uncorrelated with traditional stocks and bonds, helping to smooth out portfolio performance during market turbulence."
Bakkum says the same thing. "You want to be diversified so that you can rely on the expectation of the consistent, annualized returns generally provided by the market," according to him. As long as you have a wide portfolio of stocks, bonds, and other securities, you should not face any significant losses, especially during Fed cutbacks.
Stocks may perform poorly now that the Fed has reduced interest rates, but they have the ability to rise as lower prices make borrowing more reasonable for consumers and businesses. Investing long-term allows you to rebound from the market's inevitable dips and valleys. Portfolio diversification is critical for risk management because the stock market cannot be predicted.
"While diversification is key, it's also important to consider your personal risk tolerance and investment timeline," cautions Sarah Lee, a retirement planning specialist. "Younger investors with a longer time horizon may be able to weather more market volatility and take on more risk, while those nearing retirement might want to shift towards a more conservative allocation to protect their nest egg."
"You want to make sure you've got exposure to different areas of the market: mid-cap, small-cap, and international companies," says Jaime Eckels, financial planner and wealth management partner at Plante Moran Financial Advisors. "Decreasing rates should help smaller companies since they depend more on financing to spur growth and corporate profit."
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