When the Federal Reserve begins to lower interest rates, investors often seek out investment options that offer both high returns and safety. Finding such opportunities can be challenging, but there are strategies and asset classes that can help achieve this balance. It’s important to explore various avenues to ensure both profitability and security in your investments during periods of rate cuts.

The opportunity to benefit from 5% yields on cash is dwindling, and investors who remain in these instruments may see their returns decrease as interest rates fall. Following the Federal Reserve’s July meeting, Chairman Jerome Powell suggested that a rate cut in September could occur if inflation continues to decline. This would affect short-term investments like money market funds and high-yield savings accounts, which currently offer over 5% interest at some banks. However, investors can shift their focus to longer-term bonds to secure higher yields and potentially gain from price increases as rates drop. Bond prices and yields have an inverse relationship.

Paul Olmsted, a senior manager research analyst at Morningstar, notes that longer-term strategies are advantageous now, offering strong yields and attractive income compared to the past two decades. Duration, which measures a bond’s sensitivity to interest rate changes, is higher for bonds with longer maturities. Investors should consider reallocating from cash to fixed income.

Core bond funds are a good option for those transitioning from cash, as they provide stability and solid yields. These funds performed well during the 2008 and 2020 recessions, offering a mix of Treasurys, mortgage-backed securities, asset-backed securities, and corporate bonds, with an intermediate duration of about four to six years. Diversification within these funds can be beneficial in volatile markets. For example, Vanguard’s Core Bond Fund (VCORX) has a 30-day SEC yield of 4.47% and an expense ratio of 0.20%, with a duration of 5.9 years. Similarly, Fidelity’s Intermediate Bond Fund (FTHRX) offers a 30-day SEC yield of 4.32% and an expense ratio of 0.45%, with a duration of 3.8 years.

For higher yields, investors might consider “core plus” bond funds, which include riskier segments like high-yield bonds. Vanguard’s Core-Plus Bond Fund (VCPIX) has a 30-day SEC yield of 4.66% and an expense ratio of 0.3%, with a portion of its allocation in BB-rated and B-rated bonds, which are considered speculative grade.

Municipal bonds are another option, especially for high-income investors, as they offer tax-free income at the federal level and potentially at the state level if the investor resides in the issuing state. Although muni bonds typically yield less than corporate bonds, their tax-exempt status makes them valuable. For instance, a tax-free yield of 3% is equivalent to a taxable bond yielding 4.41% for someone in the 32% federal income tax bracket. Sean Carney of BlackRock suggests a barbell strategy using ETFs like BlackRock’s Short Maturity Municipal Bond ETF (MEAR) and High Yield Muni Income Bond ETF (HYMU) to balance duration and yield, providing low volatility and attractive returns.