The Downside of Falling Interest Rates

With the Federal Reserve expected to cut short-term interest rates later this month, investors face some tricky choices.

While falling rates are usually viewed as a boon for the stock market, that’s not the case for all parts of the investment universe. In fact, for money you may need soon, where safety is a major priority, falling interest rates aren’t great news at all.

Whenever short-term rate cuts start — and that could be as soon as the Federal Reserve’s next policymaking meeting on Sept. 17-18 — the fabulous 5 percent-plus money market yields of the last couple of years will begin to decline. Faced with the prospect of less lucrative payments from money market funds, Treasury bills, certificates of deposits and the like, you may be tempted to take on greater risks in longer-term bonds or stocks.

But the hazards of the stock market were evident this past week, when share prices tumbled globally in a reprise of the brief market meltdown of early August over concerns that the economy might be slowing. On Tuesday alone, Nvidia, the chipmaker that has been at the forefront of the artificial intelligence boom, lost 9.5 percent of its value, or $279 billion. Stock investors need to be able to ride out market storms like these. But that also requires the ability to pay your bills while the stock market gyrates. Safe, short-term holdings are essential for that purpose.

I generally favor a long-term strategy emphasizing low-cost, broad index funds that you can hold for many years, and, preferably, decades. If you’ve got a very long horizon, whether interest rates rise or fall this year doesn’t matter all that much. But that only works if you have a great deal of time. The stock market has produced outstanding long-term returns, but for money you will need soon, the stock market isn’t the solution. You may just have to accept lower yields in return for safety.

So while falling rates are wonderful if you’re looking for a mortgage or a car loan, they are not an unambiguous blessing for investors. Here are some rough guidelines on how to think about the trade-offs that falling rates pose for investors.