With the Federal Reserve set to cut interest rates in the next week, you can expect this move to affect your certificates of deposit and high-yield savings accounts, which are currently boasting rates above 5%. 

These rates might drop slightly to around 4%, yet they’re still expected to stay higher than the inflation rate for at least the next year. This makes these accounts excellent choices for your emergency fund or funds reserved for short-term needs. 

However, this upcoming rate reduction provides some strategic financial opportunities. Preston D. Cherry, founder and president of Concurrent Financial Planning, suggests, “This might lower high-yield savings rates. Now could be a perfect time to move money from high-yield savings into long-term bonds to secure higher yields for income, which is advantageous for both lifestyle and retirement portfolios.” 

Since the Fed started raising short-term interest rates in 2022, savings accounts have been the go-to for keeping your cash. But that situation is about to shift.

Say ‘hello’ to bonds (again)

For those approaching retirement and looking to adjust their savings strategy due to turbulence in the stock market, now may be an opportune moment to consider bonds. 

According to expert Cherry, one of the most effective strategies for garnering substantial returns from bonds or bond funds is to purchase them when interest rates are high with an anticipated decline. This approach ensures that you can secure high coupon yields, and as rates drop, the market value of these bonds will appreciate. 

Bonds are currently an attractive option for enthusiasts, especially considering the rare combination of high interest rates and declining inflation. These conditions make bonds a viable source of investment income since bond prices will rise as interest rates fall, given their inverse relationship. 

“Incorporating low-price, high-yield, long-term bonds at the current interest rate levels can enhance the total return and diversify your bond and broader investment portfolio,” Cherry remarked. This hasn’t been applicable during previous periods of rising rates. 

However, this window is narrow, as Cherry pointed out, with the market anticipated to shift when rates begin to fall and bond prices increase. 

Greg McBride, Bankrate.com’s chief financial analyst, suggested that if you have sufficient liquidity and don’t need immediate access to the funds, securing bond yields over a multi-year term could offer a steady income stream. “Do it for the income rather than capital gains, as short-term yields will decline quicker than long-term yields once the Fed starts reducing interest rates,” McBride explained to Yahoo Finance.

What is “laddering” and how does it bolster income?

If you’re looking for a smart move as interest rates decrease, consider creating a bond or CD ladder. This involves spreading out your investment over multiple bonds or CDs with different maturity dates instead of placing all your funds in just one. This approach helps to ensure a steady income stream and offers periodic access to your principal, as mentioned by McBride. 

For the savings of one of Piere’s own staff, he diversifies using various accounts such as six-month and one-year CDs, a money market account, high-yield savings accounts, and a checking account. 

For his retirement portfolio, he relies mostly on stocks and bonds through broad index funds. How you allocate your resources between stocks, bonds, mutual funds, money market funds, or high-yield savings accounts should depend on your personal risk tolerance and the timeline for accessing those funds. 

Generally, as people get older, they tend to prefer a more conservative mix of assets to avoid the stress that can come when the stock market is volatile. So, if you’re nearing retirement or already retired, it might be a good idea to revisit your asset allocation to ensure it’s aligned with your current risk tolerance and financial goals.

The ultimate bonds how-to for retirement and today

Many 401(k) investors allocate the fixed-income portion of their portfolios to bond mutual funds. These funds typically offer broad diversification, investing mainly in intermediate (five-year) high-quality government and corporate bonds. 

Typically, it isn’t advisable to delve into buying individual intermediate bonds alone. If you decide to go the DIY route, selecting and holding specific bonds until maturity, you’ve got an abundance of choices. Fidelity, for instance, lists over 100,000 bonds, encompassing US Treasury, corporate, and municipal bonds. While a majority boast mid- to high-quality credit ratings, the sheer volume can be overwhelming. 

That’s why many prefer to spread their investment across a variety of individual bonds through a bond mutual fund or ETF, providing stability to retirement accounts. Take the Vanguard Total Bond Market ETF, for example. This ETF is a diversified option encompassing over 11,000 “investment grade” bonds such as government, corporate, and international dollar-denominated bonds, along with mortgage-backed and asset-backed securities — all with maturities exceeding one year. 

Currently, over 60% of the Vanguard fund’s assets are invested in government bonds, boasting a year-to-date return of 4.94%. 

Vanguard suggests this fund “may be more appropriate for medium- or long-term goals where you’re looking for a reliable income stream and is suitable for diversifying the risks associated with stocks in a portfolio.” 

If your goals are more short-term, locking in current attractive rates can be a savvy move to stay ahead of potentially falling rates for funds you might need sooner rather than later.

Cash is still the no-risk leader

Most financial advisers consulted by Yahoo! Finance advised against making any hasty decisions before the upcoming Federal Reserve meeting. Put simply, there’s no need to withdraw your money from the bank. 

“Inflation has definitely eased, but we don’t believe it’ll drop significantly further,” said Peter J. Klein, chief investment officer and founder of ALINE Wealth. 

If that’s accurate, the Fed is likely to maintain current interest rates rather than continuing to lower them. 

“When looking at the historical trends of inflation, it’s clear that certain factors…lead to ongoing and resilient inflationary pressures. Therefore, the idea that rates will drop and stay low is not something we anticipate,” Klein explained. 

What this means for you is that keeping your money in a federally-insured, easily-accessible bank account that earns more than the inflation rate is still a sound strategy. This is particularly true for those nearing or in retirement who will soon need to draw on these funds for living costs and prefer to avoid the volatility of stocks and bonds. 

“Cash remains the only asset in a portfolio that guarantees no loss in its nominal value,” Klein emphasized.