Investors Find Ways to Play a Fed Rate Cut

The Federal Reserve rate cut is prompting investors and financial advisers to reposition portfolios, including buying stocks, in order to yield more income.

Fed officials lowered their benchmark rate on Wednesday by a quarter percentage point from its previous range between 2.25% and 2.5%. For some investors and money managers, the shift has felt abrupt.

Pat Savu, a retired engineer in Minneapolis, has been a fan of fixed-income investments since weathering the tech-bubble bust in the early 2000s. Back then, she put 40% of her 401(k) in bonds to help her sleep at night, and she kept a big chunk in fixed income through the financial crisis and the recovery that followed. Lately, she and her husband are moving some of that money around in response to shifting Fed expectations.

“It’s made me change what I’m doing,” Ms. Savu said of the Fed’s flip from raising rates after a decade at rock bottom and now heading back lower. “Treasurys are really stable but they don’t pay,” she said. Meanwhile, Ms. Savu said she is now putting the money she had in individual municipal bonds in muni bond funds, where she is still getting 4% or more in annual income.

Many financial advisers expect the Fed to lower rates at least once more this year. David Romhilt, chief investment officer at Summit Trail Advisors in New York, said his firm is counseling clients to make several changes given the turn in monetary policy. Many were holding on to more cash or short-term municipal funds, but it now makes less sense to hold shorter-duration securities that tend to be more sensitive to monetary policy, he said.

One way investors can get exposure to medium- and longer-term municipal bonds, he said, is by buying funds such as Vanguard’s Intermediate-Term Tax-Exempt Fund and Long-Term Tax-Exempt Fund.

In addition to recommending a shift in duration, Mr. Romhilt said his firm is moving clients out of corporate credit and into mortgage funds. Falling interest rates will support home prices and encourage mortgage refinancing, he said, while corporate credit yields have declined. “You’re not being compensated for the risk,” while mortgages that survived the financial crisis have been stress-tested and could make sense, Mr. Romhilt said.

Despite the message rate cuts typically send, investment strategists and financial advisers say investors shouldn’t shy away from the stock market. David Lefkowitz, senior equity strategist at

UBS Group
AG

’s wealth management business, said lower interest rates should fuel economic growth and prolong the bull market.

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In particular, Mr. Lefkowitz said shares of companies that are tied to consumer spending, such as e-commerce, are poised to benefit from reduced borrowing costs. Mr. Romhilt, meanwhile, said yields on some stocks in the consumer staples, health-care, telecom and utility sectors will be relatively attractive amid lower rates and in the event of a market decline. Advisers at his firm use the iShares Select Dividend ETF, he said, to provide diversified exposure to income-generating stocks.

Because lower rates are meant in part to stoke inflation, advisers and strategists say it is important for investors to hedge now. UBS’s Mr. Lefkowitz said investors should consider Treasury inflation-protected securities, or TIPS, because the principal adjusts based on inflation, making them most desirable to investors when they believe prices across the economy are heading higher.

The Federal Reserve is expected to cut interest rates on Wednesday, although the U.S. economy is doing pretty well. WSJ’s Heard on the Street columnist Justin Lahart asks, “What’s the rush?” Photo illustration: Laura Kammermann

Write to Lisa Beilfuss at lisa.beilfuss@wsj.com

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