Strategies for Your Money When Interest Rates Decline

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What to Do with Your Money as Interest Rates Fall?

When interest rates decline, it has a significant impact on the markets, influencing investment decisions.
With the European Central Bank already beginning to ease borrowing costs and the Fed likely to follow suit, many investors are keen to understand the strategies that can help them better manage their savings in a lowering rate environment.

Interest rates are crucial when deciding to invest in stocks, bonds, or simply open a savings account.
They indicate how much your money can earn and the cost of borrowing funds.
In essence, they help define the opportunity cost of holding cash: low rates mean minimal returns on deposits, prompting a willingness to invest in riskier assets like stocks or bonds for potentially higher yields.

Calculating the Impact of Falling Interest Rates on Investments

Mathematically, the value of investments can be estimated by discounting future cash flows.
A reduction in interest rates increases the present value of future cash flows, thereby enhancing the overall asset value.
Let’s explore which investment choices to consider in a declining rate trend.

1) Money in Savings Accounts

If you’ve deposited funds in a savings account months ago, before the interest cuts, there’s nothing to worry about: the agreed rate with your bank remains unchanged until maturity.
However, opening a new fixed-term savings account today could yield lower returns due to the ECB’s new deposit rate of 3.50%, allowing banks to lower the interest they offer savers.

Market expectations have already affected fixed-term deposit rates, decreasing by 15-25 basis points since June.
Future offerings from banks are likely to drop even further.

2) Investing in Stocks

Investing in stocks during declining interest rates can be beneficial: lower rates can stimulate economic growth, making loans cheaper for both businesses and consumers, positively affecting stock prices.
However, the impact of rate cuts isn’t uniform across all investments and must be contextualized within the current economic cycle, which still feels the effects of pandemic-induced disruptions.

Typically, as rates decrease, portfolios tend to shift from value stocks to growth stocks.
Value stocks, like Eni or Enel, consist of companies with stable short-term earnings that are less sensitive to rate changes.
Conversely, growth stocks, such as Nvidia, thrive in low-rate environments, as they rely on loans for expansion, making borrowing costs more favorable.

3) Investing in Bonds

Investing in bonds during periods of declining interest rates is an excellent strategy to lock in yields while they are still high.
There’s an inverse relationship between rates and bond prices: as rates fall, the value of previously issued bonds with higher coupons goes up.
Selling these bonds on the secondary market before maturity can be a lucrative option.

It’s essential to note that the sensitivity to rate changes varies with the bond’s maturity.
Long-term bonds, like the 10-year BTP, are more affected by rate drops than short-term bonds.
For instance, the yield on the 10-year BTP decreased significantly, increasing its price.
Investors are encouraged to consider adding high-yield, low-priced long-term bonds to their portfolios while diversifying maturity dates.

DISCLAIMER

The information provided in this article should not be used as the only basis for investment decisions.
Readers retain full freedom in their investment choices and accept complete responsibility for their decisions, as they alone understand their risk tolerance and time horizons.
This article’s information is for informational purposes only and should not be considered an offer or solicitation for public savings.

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