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Why the Fed Put These Stocks Ahead of Savers

Here's a short description of what's happened so far this week, put in language a first-grader could understand:

When the U.S. had its debt downgraded, the Treasury Department was mad at S&P. Yet while the Treasury couldn't really fight back itself, the big bad Federal Reserve decided to stick up for its monetary cousin and sent the bully rating agency running home to Momma.

OK, so maybe a first-grader wouldn't get the debt downgrade part. But there definitely is a fight going on, one that policymakers desperately need to win at any cost.

The Fed's move may not have been a vote of confidence in the economy, but it certainly helped boost stock prices. Still, every move has winners and losers -- not to mention unintended consequences -- and in this case, those who rely on low-risk savings vehicles will pay the price.

Those pesky savers
For retirees and other conservative investors, having money in liquid savings accounts isn't a luxury -- it's a necessity. You simply can't afford to have all your money tied up in risky investments like stocks when you know you've got bills to pay later this month.

But when the Fed promises to keep interest rates low, as it did yesterday, it hurts retirees by sapping their income. Instead of being able to live off their interest income, as they did when short-term rates were closer to 5%, retirees have to tap slowly but steadily into their principal, increasing their chances of ending up penniless.

That, however, isn't what the Fed is most concerned with. Throughout the extended financial crisis of the past several years, the Fed and the Federal government have demonstrated a concerted effort to make saving as unattractive as possible.

The reason is simple: Savings thwarts the general mission of jumpstarting economic activity. When the Fed boosts money supply and the Treasury does things like handing out temporary tax cuts, the last thing they want is for that money to go straight into a bank -- and then have that bank deposit it right back at the Fed's doorstep rather than lending it out.

Betting on the borrowers
No, it's a borrower's world right now, and investing with that in mind could make you rich. Consider these winners from the latest battle in the ongoing interest rate tug-of-war:

  • Highly leveraged companies got a big boost from the Fed's promise to keep short-term rates low. For instance, mortgage REITs American Capital Agency (Nasdaq: AGNC  ) and Cypress Sharpridge (NYSE: CYS  ) jumped sharply after the Fed announcement yesterday, as it appears their source of cheap financing will last at least until 2013.
  • Beaten-down banks Citigroup (NYSE: C  ) and Wells Fargo (NYSE: WFC  ) also gained back some of their losses after the Fed move. By helping banks keep rates on savings low, the Fed paves the way to let them keep their interest income levels higher -- potentially averting a capital crisis down the road.
  • Capital-intensive industries depend on access to borrowing, so the cut is good news for them. For instance, Brigus Gold (AMEX: BRD  ) and Northgate Minerals (AMEX: NXG  ) both have key projects in development or coming on line, and they'll need money to get them going. The Fed's move goes a long way toward ensuring that they'll get it.

In addition, the move will inevitably boost dividend stocks of all kinds. Whether it's safe or not, retirees simply have no good income-producing alternative right now. So expect not just individual dividend stocks, but also dividend-oriented ETFs like Vanguard High-Yield (NYSE: VYM  ) , to thrive.

Don't take it personally
Retirees may feel like the Fed hates them, but it's just business. With the government on a mission to restore growth, savers are a lower priority. Rather than letting the Fed walk all over you, you can take steps to profit from those anti-saving moves.

Learn more about how dividend stocks can help your portfolio by reading this free special report from The Motley Fool. Inside, you'll find 13 names, along with analysis to tell you why we think they might fit well in your portfolio.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter here.

Fool contributor Dan Caplinger is tired of seeing savers get shafted. He doesn't own shares of the companies mentioned in this article. The Fool owns shares of and has created a ratio put spread position on Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy never leaves you out.


Read/Post Comments (5) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 10, 2011, at 6:44 PM, easyavenue wrote:

    Another good article, Dan. Thanks!

  • Report this Comment On August 10, 2011, at 10:42 PM, rfaramir wrote:

    "Throughout the extended financial crisis of the past several years, the Fed and the Federal government have demonstrated a concerted effort to make saving as unattractive as possible."

    This is the damage that the Fed does by increasing the money supply: it makes saving unattractive.

    Why are so many people so far indebted? No incentive to save, much incentive to borrow.

    Savings makes investment possible. Investment in capital goods makes workers more productive. More productivity means more wealth for us all.

    Printing money does not make investment happen, saving does. Printing money alters the structure of production for the worse. It makes endeavors which otherwise are unattractive look attractive (at a lower interest rate), tempting unwise investment.

    End the Fed. End overspending by government.

  • Report this Comment On August 11, 2011, at 2:20 PM, chadscards1274 wrote:

    Couple of quick points:

    1. When short term rates were at 5% are we assuming benign inflation? If so then the premise of this article makes sense. If not then we are starting off on the wrong foot. Except for a person who is very old most people don't have all of their money in savings accounts.

    2. Depending on what age you are assuming we are talking about there are very few people who have the assets to put all or most of their money into regular savings vehicles. Most financial planners I believe would say that these "savers" should have a reasonable amount of money in liquid assets where the main issue is preservation of principal and not what they earn. In most cases people should then have a chunk of change in less liquid but safer investments like CD's, MM, short term bonds maybe. The remainder of the person's portfolio would be in some type of growth investment.

    3. The problem is except for a person who has a substaintial net worth there are very few people who should think that a savings vehicle of any kind is where all of their money should be. In addition given the number of world class companies selling at a discount to where they have been over the last 10 - 15 years and the fact that some of these world class companies have dividend yields of 4%+ I don't know that the low short term interest rate environment is the worst thing that could happen.

    4. investment in capital goods is equally possible for savers and borrowers. There are hundreds of companies and small businesses that use the power of leverage to borrow at today's very low rates to invest in the future of their company which causes growth which equals jobs and tax revenue.

    Last, the Fed understands that they need people to spend money. The reason there isn't more incentive to save through higher short term rates is the economy needs to be pushed along. The economy gets not lift from a bunch of people putting more and more money in the bank. If the Fed raised short term rates this does bring an incentive to save, but it also makes those who are in debt (particularly adjustable rate debt) in worse position. It also changes what banks can lend money at because their cost of funds would be higher. This hurts individuals who might want to improve their house through a home equity line or loan, raises car loan rates, etc. How would that make the economy better? The reality is if you want better rates you have to take on more risk, if you expected to put all of your money in savings and that you would make enough to live off of I think you started with a bad assumption.

  • Report this Comment On August 11, 2011, at 7:16 PM, surfgeezer wrote:

    Well said Mhenage- you hit on the same points as me. Would also add the subtle gold pump was not lost. ALL biz use leverage of some kind, very difficult to run a competitive biz without paying some interest.

    rfaramir is completely wrong. The FED merely deals with the incompetence of politicians and without the FED, who do you think does monetary policy? Low saving rates are just the other edge of the sword. It is financial suicide to ask for high rates at best and political incompetence.

  • Report this Comment On August 12, 2011, at 4:10 PM, Tomohawk52 wrote:

    Maybe if more people saved money instead of taking out loans for granite counter tops and stainless steel appliances North America wouldn't be in this predicament. People who thought real estate would always go up, who thought they could spend tomorrow's income on today's gluttonous consumption started with a bad assumption - that they deserved a standard of living they had not earned.

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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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