So you have a money market account and invest in a money market fund. You feel that your money is safe and you can access it quickly but the interest rate is nothing to write home about. That’s about all most of us know about these money market instruments so as educated Blue Collar Investors we need to explore this subject in greater detail.
The money market is a segment of the financial market where businesses, institutional investors and the U.S. Government meet to buy and sell highly liquid (easy to buy and sell), short term debt securities. The money supply is controlled by the Federal Reserve Bank by buying and selling certain negotiable securities.
Retail, Blue Collar Investors can only participate in this market indirectly by investing in a money market fund established by broker-dealers, or by saving in a pension fund that purchases money market instrumenmts. This is because it takes huge sums of money to enter this market.
Money Market Savings Account:
This is a bank liability. We deposit our cash in the bank and the bank owes us money. This money is not specifically aligned with any particular assets that the bank invests in, it simply is an obligation of the bank and therefore our risk is with the bank and nothing else. However, much like checking accounts, these accounts are insured by the FDIC. There is usually a limitation on the number of transactions that can be made in a money market savings account and a minimum balance must be maintained. From the bank’s perspective, our money is used to provide loans to other bank clients. The interest rate charged for these loans is higher than the interest paid to us in our money market savings accounts and the bank therefore realizes a profit.
Money Market Fund:
This is a mutual fund wherein investors do not acquire shares in the underlying assets but rather in the fund itself. These shares are maintained in $1 denominations. Based on the returns that the fund is earning, interest is paid in the form of additional $1 shares. If we write a check for $1000, the fund simply sells 1000 shares. Certain rules regarding the type of securities (high-quality, liquid debt and monetary instruments) are allowed to be held in these funds and the diversification of them must be adhered to. Our risk lies in the actual assets, not the bank or brokerage behind these funds. These funds hold 26% of mutual fund assets in the U.S. because of the low-risk, high liquidity features.
Assets in a Money Market Fund:
1- Commercial Paper– Unsecured, short-term debt (promissory notes) issued by corporations and banks. They mature in 270 days or less and are usually issued by highly regarded firms with outstanding credit ratings.
2- Jumbo CDs– Also called negotiable certificates of deposit, these instruments pay interest to the investor. These are not the same CDs we are used to. The minimum size is $100,000, but amounts of a million or more is common. These are the favorite vehicles for money market managers.
3- Banker’s Acceptances– These are time drafts written by a business and guaranteed by its bank which enables the business to export or import goods. In essence, the bank is lending money to the business to pay for the imports against the collateral that those goods provide.
4- Repurchase Agreements (Repo)- This is where the seller of a debt security (usually a Treasury security) agrees to buy the security back within a short time frame for a specified amount. The buyer makes a profit by setting the “sell-back” price higher than the original purchase price.
The money market world is a relatively safe haven for our money wherein we can readily access the cash. In return for our money, we receive a slightly higher interest rate than a typical savings or checking account but much lower than that of higher risk investments (stocks and corporate bonds). We can put our funds in a money market savings account which is backed by the particular bank and also insured by the FDIC or into a money market fund which is backed by the actual assets purchased by the fund. The concept of asset allocation and diversification makes this vehicle a viable option in our overall portfolio. However, to place all our eggs in this basket will subject us to inflation (earn 2% but cost of goods goes up 3%) , purchasing power and opportunity risk (money lost by not investing in other, higher-yielding investments).
Industry in the Spotlight- Computer Networking Stocks:
In the past we have discussed the Gold/Silver Group as an industry that has caught the attention of the “big boys”or institutional investors. In the last 10 weeks, this group has gone from out of favor to a top industry in terms of new institutional money flowing in. Coal stocks now top this group and has been a favorite for several months. So I decided to seek out an industry that has been gaining momentum but in an inconspicous manner. Computer networking stocks fit that bill. Here is a chart of that group versus the S&P 500:
Since March, this industry (depicted by the top line) has far outperformed the broad market benchmark. Here are a few stocks in this group that are performing well:
- BCSI (this one keeps coming up!)
Here is a chart showing the 2009 charts for BCSI, FFIV and the S&P 500:
- BCSI- TOP GREEN
- FFIV- MIDDLE BLACK
- S&P 500- LOWER BLUE
Last Week’s Economic News:
New home construction fell to a 6-month low in October but leading economic indicators as reported by the Conference Board rose for the seventh consecutive month (0.3% in October). The Consumer Price Index (CPI) rose slightly, mainly due to higher fuel oil prices while the Producer Price Index (PPI) rose less than expected, allaying inflationary fears. Retail sales increased in October, thanks, in large part, to an enhanced demand for cars. For the week, the S&P 500 fell 0.2% for a year-to-date return of 23%.
This Week’s Economic Reports:
- Monday: Existing home sales
- Tuesday: Consumer confidence, FOMC release of meeting minutes, GDP
- Wednesday: Durable goods orders, new home sales, personal income spending stats.
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Wishing all our readers and their families a wonderful Thanksgiving Holiday,
Alan and Linda Ellman