Lucy Lambriex | Stone | Getty Images
As the Federal Reserve cuts interest rates, investors should review their bond portfolio, which could see a boost from dovish Fed policy.
The central bank in September kicked off its first easing campaign in four years with a 50 basis point rate cut, which brought its benchmark rate to a range of 4.75% to 5%.
After a better-than-expected jobs report last week, analysts predict future rate cuts could be smaller.
However, the Fed policy shift could be good 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 again,” said certified financial planner Scott Ward, senior vice president of Compound Planning in Birmingham, Alabama.
More from Personal Finance:
How tax brackets increases could affect your brokerage account
Crypto relationship scams pose ‘catastrophic harm,’ SEC says
Many Americans would rather talk about politics than money
In 2022 and 2023, the Fed enacted a series of rate hikes, which led to higher yields on savings, money market funds, certificates of deposit and other options.
While it may be tempting to cling to cash, it will become “less attractive, less productive as 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 some options to consider, according to financial advisors.
Corporate bonds
In a falling-rate environment, you may consider medium- to longer-term corporate bonds, according to Ted Jenkin, founder and CEO of oXYGen Financial in Atlanta.
During the third quarter of 2024, the Morningstar US Corporate Bond Index, which measures investment-grade corporate bonds, returned 5.8%, which was higher than the overall bond market at 5.2%.
Many corporations leveraged rock-bottom interest rates during the pandemic to strengthen balance sheets and refinance debt, said Ward.
“I think we’ll see corporations emerge from this rate hike cycle in pretty good shape,” he said.
Municipal bonds
As investors brace for possible higher future taxes, municipal bonds could become more appealing, particularly among residents in higher-income tax states.
Muni bond interest is federally tax-free and avoids state levies when you live in the issuing state. Typically, muni bonds have lower default risk than corporate bonds.
“Longer-term municipal bonds should fare better if the Fed continues to cut interest rates,” said Jenkin, who is also a member of Tech Zone Daily’s Financial Advisor Council.
“Municipalities present a couple of excellent qualities for long-term investors,” including the potential for attractive yield combined with a lower risk profile, Ward said.
Advisors extend bond ‘duration’
When constructing a bond portfolio, advisors weigh duration, which measures a bond’s sensitivity to interest rate changes. Expressed in years, the duration formula includes the bond’s coupon, time to maturity and yield paid through the term.
Some advisors began increasing bond duration before the Fed’s first interest cut in September.
Jenkin said his firm started shifting to “medium-term duration” bonds, which he defines as five to 10 years, roughly four months before the Fed’s first rate cut.
As interest rates fall, those longer-maturity bonds should reward investors, experts say.
