The Bank of Canada’s recent interest-rate cuts are the first rate reductions in about four years. We’ve become familiar with the impact of rising rates on our mutual fund investments, but what about the effect of falling rates?

Money market funds

When interest rates increased during the past couple of years, money market fund returns also increased, upward of 4% in 2023 and higher than 3% for much of 2024. Many investors chose money market funds not only to achieve short-term goals but as part of their fixed-income allocation to meet long-term savings objectives.

But money market rates fall as the Bank of Canada reduces its benchmark interest rate. This means that anyone who invested in money market funds for a long-term goal faces a decision. Will you remain on track to achieve your goals or should you invest those dollars elsewhere, such as in bonds?

Bond funds

Generally, falling interest rates are good news for current bond fund investors. That’s because newly issued bonds have lower yields, which makes existing bonds with higher rates more valuable in the bond market.

Some investors may be hesitant to invest in bonds due to the recent underperformance – bond funds suffered negative returns in 2021 and 2022. But two consecutive years of negative returns is an extremely rare occurrence. That period was marked by high inflation and rapid interest-rate hikes. Now, inflation is under control and interest rates are decreasing.

Equity mutual funds

Falling interest rates have the potential to positively affect the stock market. Lower rates mean lower borrowing costs, which can increase a corporation’s profitability and encourage companies to invest in their own growth. Also, lower rates can stimulate consumer spending. However, equity fund performance is affected by a variety of factors, so rate cuts on their own won’t necessarily control the direction of the stock market.