Rate Cuts and Retirement Saving

The Federal Reserve’s interest rate cut finally came Wednesday with a one-half-percentage-point reduction.

The cut was on the larger side of the Fed’s expected options, showing its confidence that inflation is coming down but also its concern about the labor market, says Mark Hackett, chief of investment research for Nationwide.

“Easing inflation conditions and a slowing labor market were the drivers of the decision, though current economic data remain healthy,” he says.

At first blush, markets responded well, Hackett notes, with the S&P 500 rising to a “record high before softening during [the Fed’s] press conference.” Markets eventually closed slightly down on Wednesday.

Meanwhile, the Fed’s Summary of Economic Projections, or “dot plot,” forecasts continued rate cuts this year into next, with “the median year-end funds rate embedding 100 basis points of cuts, suggesting a 0.25% cut in November and December,” Hackett says.

For defined contribution retirement investing, a rate cut regime is likely to have a few long-lasting effects, according to asset managers. These include more focus on capital preservation, a shift toward alternatives to find stronger returns, and a potential rise of stable value funds, with their low-risk returns no longer being outmatched by vehicles such as money market funds.

“DC participants near or in retirement are most likely to feel the most acute impact,” says Brad Long, chief investment officer at Fiducient Advisors. “Higher interest rates tend to favor those seeking income. If rates keep falling, retirement income programs or stable value options may become more attractive compared to traditional money market funds.”

More Expensive

On a broad scale, lower rates will make retirement investing “more expensive,” says David Blanchett, managing director, portfolio manager and head of retirement research for PGIM DC Solutions.

“Think of retirement as a liability: As rates fall, the cost of covering the liability rises,” he explains. “This means higher required savings rates.”

That may reignite conversations about diversifying assets, such as investing in alternatives, for long-term DC investors to generate higher returns.

“There has already been a shift toward alts; I think lower yields could accelerate things,” Blanchett says.

Tim Braude, head of multi-asset solutions for Goldman Sachs Asset Management, agrees with a likely shift toward alternative investment strategies, assuming rates continue to come down.

“Longer term, we continue to see increased adoption of alternatives, as private credit and private equity products that are suitable for retirement accounts come to market,” Braude says via email. “Given the long-term nature of DC assets, we believe there is strong alignment with the profile of private asset investment horizon.”

According to Nick Nefouse, head of retirement solutions at BlackRock, the signaling of lower interest rates to come has already created some benefit for long-term TDF investors, with potentially more to come.

“Target-date-fund investors are already reaping the benefits of the decline in interest rates,” Nefouse says via email. “This has led to a rally in the Aggregate Bond Index, which has seen a return of approximately 5% this year.”  

Nefouse says BlackRock, in recent years, disaggregated its fixed-income portfolios, “diversifying the fixed-income allocation by duration and credit to give our portfolio managers more precision around fixed-income investments.” Nefouse says the approach was “particularly advantageous for older investors who typically have larger allocations to bonds.”

Seeking Stability

In its recent 2024 DC Consultant Study, asset manager T. Rowe Price found that plan consultants and advisers are anticipating an increased focus on capital preservation for savers.

With interest rates no longer offering strong returns for investments such as money market funds, that could mean a return toward insurance-backed stable value funds, according to Jessica Sclafani, a senior defined contribution strategist at T. Rowe Price.

“We believe that the Federal Reserve’s policy shift will signal the beginning of the end for the prolonged period during which money market fund yields have exceeded stable value crediting rates,” she says.

Sclafani notes that recent discussions the firm has had with advisers and plan sponsors signal a desire to improve stable value crediting rates and performance, including “repositioning portfolios, transitioning from collective investment trusts to separate accounts, adding external managers, and incorporating stable value, plus sectors like equities and high-yield bonds.”

The lower-rate environment may also mean expanded and more creative use of stable value by retirement savers, such as “finding creative ways to utilize investment contracts (“wraps”) in products like TDFs and retirement income solutions, allowing us to take advantage of higher yields and lower volatility by wrapping both fixed income and equities,” Sclafani says.

Kelly Berry, the chief financial officer for Nationwide Retirement Solutions, agrees that lower rates may stem the tide of a “subset of retirees” who left stable value investments for money market accounts when rates went up.

“Retirement plans are often the most efficient way for participants to save,” she says via email. “Longer term, the stable value investment is true to the name, and we believe it’s a great option for retirees to keep their money in this kind of investment inside their workplace retirement plan.”

Blanchett, the DC retirement research head for Prudential’s asset management division, also notes the attractiveness of lifetime income strategies, such as annuities, as being attractive in a lower-yield savings environment.

“This isn’t necessarily super obvious, but there are two components that drive annuity payouts: the longevity component and bond yields,” he says. “The longevity component is effectively constant, which means lower yields make it relatively more attractive to buy an annuity versus self-insuring retirement with savings.”