Lucy Lambriex | Stone | Getty Images
As the Federal Reserve cuts interest rates, investors should review their bond portfolio, which could get a boost from the Fed's dovish policies.
In September, the central bank launched its first easing campaign in four years with a 50 basis point rate cut, bringing its key interest rate to a range of 4.75% to 5%.
After last week's better-than-expected jobs report, analysts are predicting future rate cuts could be smaller.
However, the Fed's policy change could be beneficial for parts of the bond market, experts say. Typically, bond prices and market interest rates move in opposite directions.
“This is a fantastic time to revisit bonds,” said certified financial planner Scott Ward, senior vice president of Compound Planning in Birmingham, Alabama.
More from Personal Finance:
How tax bracket increases could affect your brokerage account
Crypto Relationship Fraud Constitutes “Catastrophic Harm,” SEC Says
Many Americans would rather talk about politics than money
In 2022 and 2023, the Fed implemented a series of interest rate hikes that resulted in higher returns on savings, money market funds, certificates of deposit and other options.
While it's tempting to hold on to cash, it becomes “less attractive and less productive when interest rates fall,” Ward said.
Long-term investors can now “get a lot more return from the safer side of the portfolio” with bonds, he said.
Here are a few options to consider, according to financial advisors.
Corporate bonds
In a falling interest rate environment, you might consider intermediate- to longer-term corporate bonds, said Ted Jenkin, founder and CEO of oXYGen Financial in Atlanta.
In the third quarter of 2024, the Morningstar US Corporate Bond Index, which measures investment-grade corporate bonds, returned 5.8%, outpacing the overall bond market's return of 5.2%.
Many companies took advantage of rock-bottom interest rates during the pandemic to strengthen their balance sheets and refinance debt, Ward said.
“I think we'll see companies weather this rate hike cycle pretty well,” he said.
Municipal bonds
As investors prepare for possible higher taxes in the future, municipal bonds could become more attractive, particularly for residents in states with higher income taxes.
Municipal bond interest is tax-free federally and there are no state taxes if you live in the issuing state. Typically, municipal bonds have a lower risk of default than corporate bonds.
“Longer-term municipal bonds should perform better if the Fed continues to cut rates,” said Jenkin, who is also a member of CNBC’s Financial Advisor Council.
“Municipalities offer some excellent attributes for long-term investors,” including the potential for attractive returns combined with a lower risk profile, Ward said.
Advisors extend bond term
When building a bond portfolio, advisors consider duration, which measures a bond's sensitivity to changes in interest rates. The duration formula, expressed in years, includes the bond's coupon rate, the remaining term to maturity, and the yield paid over the term.
Some advisers began extending the bond's maturity even before the Fed's first rate cut in September.
Jenkin said his company began switching to “intermediate-term” bonds, which he defines as five to 10 years, about four months before the Fed's first rate cut.
As interest rates fall, these longer-term bonds should reward investors, experts say.
Don't miss these insights from CNBC PRO
Comments are closed.