Recession Vs. a Money Market Savings Account
Money market funds are a safe investment and a good place to hide out during a recession until there is a definite direction established in either the bond market or the stock market. For example, if you own bonds with high interest rates and interest rates are coming down, stay in those bonds as long as possible and, when rates are at their lowest, sell the bonds at a profit and move your money into money market instruments until the stock market begins to rally because of a recovering economy. When the economy is strong, interest rates will rise and this is the time to sell your stocks at a profit and move into bonds. Simple? Well, not exactly.
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Fed Monetary Policy
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The key to understanding when to be in money market funds and when to invest in other securities is understanding how the Federal Reserve uses monetary policy to manipulate the economy. When the economy is strong there is demand for money from corporations that want to expand and consumers who want to buy things. When there is demand for money, interest rates naturally rise. When the economy is getting too strong, and inflation begins to worry the Fed, its monetary policy will become restrictive. That means it will take steps to raise interest rates even further to make money too expensive to borrow. That slows the economy and brings on a recession. If the Fed moves at the right time, the recession will be shallow and not too damaging. At the bottom of the recession, known as the trough, the Fed will switch to expansionary monetary policy, adding money to the system and lowering interest rates to make borrowing easier. This spurs economic growth.
Boom Times
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When the economy is strong, the stock market rallies because corporations are making good profits. At this time it is better to be invested in the common stock of companies that will benefit most. As the economy reaches a point where it is time to start taking profits in some of your stock investments, money market funds will probably be paying reasonably good interest rates because interest rates rise as the economy reaches a peak. Anticipating an eventual move by the Fed to cool the economy, you should take profits in your stock and move into bonds with high coupon rates of interest.
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Recession
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When the Fed starts to choke off the economy by raising interest rates, it's a good time to continue buying and holding bonds. Do not keep your money in money market funds because they will experience a drop in interest rates. As the recession begins, the Fed may move to lower rates, but the lowest rates will come just after the trough, when the Fed will be encouraging economic growth. This is when you sell your bonds and move into money market funds until the stock market starts to rebound.
Money Market Funds
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If interest rates are beginning to rise and you want a safer investment than the stock market, money market funds are where you should put your money. The rates they pay will increase as interest rates increase. However, when interest rates begin to decline, holding on to your money market funds will assure you of lower rates of return. That is why an investment in longer term bonds will lock in high rates of return, which will be increased by profits if you sell those bonds as interest rates hit their cyclical lows.
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