One of the key roles of the Federal Reserve is to control monetary policy. What exactly this means and how it is done can all seem rather mysterious and beyond comprehension. However, a powerful tool in their bag of tricks is control of interest rates.

Whether we realize it or not, interest rates largely control our decisions to save, spend and invest. When interest rates are high, we tend not to borrow because it is costly. Saving is enticing, however, because we can earn comparatively more on money we leave in the bank. When interest rates are low, borrowing (and spending) is encouraged because it is comparatively inexpensive, and saving is perceived to be more costly given the lack of income from money left in the bank.

However, making money decisions based on Federal Reserve policies can impose more significant consequences than we are led to believe.

Leading up to the 2008 stock market crash, interest rates were falling, and investors were led to buy stock instead of accumulating money in the bank. Holding cash was perceived to be costly, and many investors put all their cash in the stock market. Behind the scenes, the Federal Reserve’s monetary policies were aimed at controlling the stock market for the benefit of a few wealthy investors rather than controlling monetary policy for the whole nation. The resulting stock market crash enabled one of the largest transfers of wealth our nation has ever known.

Rather than hold their positions, the average investor believed it was better to sell – when the market was going down or at the bottom. These sales completed the transfer of wealth. Few investors had cash to capitalize on the struggling market, and the fate of their investment portfolios and retirement accounts was sealed.

Although we’re told cash does not serve any useful purpose in an investment portfolio, this message is rather self-serving in favor of wealthy bankers and stock brokers.

The investors who did well during the market crash had plenty of cash in their portfolios, did not sell all of their positions, and used cash reserves to take advantage of discount prices, riding the wave back up.

Saving serves many useful purposes for the average person, even though it does not currently offer sexy returns. Cash ensures you have the resources to survive fluctuations in your income and address crises and emergencies that arise in your home. Cash enables you to take advantage of opportunities you would otherwise pass up without cash on hand. Cash insulates a portion of an investment portfolio from wild swings in the value of investments.

Urges to borrow and spend should be ignored, especially while interest rates remain enticingly low. When cash is scarce, values of assets rise because available cash is chasing a limited number of assets – think the housing market, again! To borrow during such a time puts you at risk for being underwater when values predictably fall. Then when the loan is foreclosed, whatever cash you invested is lost. This will particularly come true when the Federal Reserve raise interest rates, signaling investors to hold cash. An increase in spending also puts your financial plan on thin ice. Less cash means you have fewer resources to address emergencies.

When you are not insulated against market swings and personal emergencies, you become more at risk for financial disaster. Those in poverty and earning low incomes are more sharply affected during these times because they have fewer resources to address household needs, and losing even a small amount of money on investments and financed purchases can be financially devastating.

While Federal Reserve policies once favored a strong national economy, their more recent policies favor transferring wealth away from the common citizen. Buyer beware!
 


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    Climbing the Money Tree


    Author

    R. Joseph Ritter, Jr. CFP® is a CERTIFIED FINANCIAL PLANNER(TM) and founder of Zacchaeus Financial Counseling, Inc., a non-profit organization providing financial planning services to low-income households and households experiencing financial strain.

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