Investors Are Abandoning Money Market Funds & Flocking to This, But Should You?

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It has been an odd bear market.

Ordinarily, during market downturns and volatility, investors seek safe places to put their money. In the way of investment, this is both a reaction to and a cause of stock market troubles. As stocks begin to sag, investors pull their money out of equities and put it into more stable assets. Most notably, this leads to growing investment in money market funds and bonds. As investors pull their money out of equities stock prices dip, creating a feedback loop that tends to last until investors decide that the opportunities outweigh the risks.

This is a longstanding pattern. In fact, students of market history can track the value of money market funds alone against the S&P 500. What they’ll find is a fairly neat asymmetry. Whether in 1998, 2002 or 2008, to name just a few examples, money market funds have grown counter cyclically against the S&P 500.

With a big recent exception. Investors now seem to be pouring money into stocks from money market funds.

For help strategizing how to play this particular market, consider working a financial advisor.

Moving Money From Money Market Accounts to the Stock Market

As Morningstar reports, investors “are showing no signs of bailing out of the markets.” In fact, they’re taking it a step further.

“Over the course of this year, cash has been moved out of money market funds and investors continue to put money to work in stock funds, while bond funds have seen outflows,” Morningstar reports. “Investors [aren’t] parking cash in money market funds like they did in other volatile periods.”

In March 2020, for example, investors put $686 billion into money market funds, according to Morningstar. This year, by contrast, they yanked almost $200 billion from money market funds.

Over the course of 2022, investors have steadily been pulling cash out of money market funds and into equity funds fueling high liquidity. The average cash position of a stock fund was higher than at any time in the past decade. In fact, as Morningstar finds, investors added almost $3.1 billion to equity portfolios in third quarter 2022 alone.

This is a strongly bullish position during what has been an otherwise very troubled year. Over the course of 2022, the S&P 500 has lost more than a fifth of its value, dropping from around 4,700 points in early January to 3,600 points in early October. So what exactly is going on here?

Why Are Funds Flowing to Stocks?

One best guess is a practice called “rebalancing.”

As Morningstar notes in its report, “[f]lows into U.S. equity funds are on pace to fall well short of 2021.” Investors aren’t moving their money fully back into the stock market yet, as evidenced by its continued weakness. Instead, they might simply be reallocating their funds to a more balanced approach. Money market fund investment climbed steadily through 2021 and has fallen in 2022, with investors moving much of that money back into equity funds. Morningstar’s researchers suggest that this might reflect “routine rebalancing,” as investors stick to their long term plans.

In that case, this would be a natural investment cycle. Investors put more money into safe assets like money market funds and bonds throughout 2021, and are now shifting some money back toward equities to reflect the mix of assets they’d like to hold. In that case, this is most likely the behavior of long-term investors who are reallocating toward equities based on how they expect the stock market to perform over the next several years, not necessarily the coming months.

For individual investors, the question is whether or not to follow suit.

During a troubled stock market, like now, investing advice follows two major schools of thought.

First, seek safe assets. Market volatility means that you can’t know what to expect. Anything could fluctuate in value, putting your money at risk. Just as importantly the market might be undergoing a fundamental revaluation, meaning that assets might settle at new, lower values once stability resumes. For that reason, you should tend to invest in stable and credit-based assets like bonds, money market funds and banking products during a volatile market. This will give you a better rate of return than a simple savings account, while letting you wait out equity uncertainty.

Second, alternatively, invest while the market is down. As Warren Buffet likes to say, buy when everyone is selling and sell when everyone is buying. During a bear market, stock prices represent systematic risk, meaning that prices are down because the market as a whole is suffering. This gives you an opportunity to purchase underpriced assets while they’re selling at a market-based discount, then hold those assets once their fundamental value begins to reassert itself. This gives you a much stronger opportunity for growth than you can achieve by purchasing assets during a strong market when prices are high.

If you follow the first school of thought, you should currently have your money out of equity funds and in credit-based products like money market funds and bonds. If you follow the second school of thought, you should have spent the last two quarters moving money out of those assets and into equities to take advantage of falling prices.

This is where rebalancing comes in. There’s no foolproof way to tell in advance which approach is right during a bear market. You might have invested heavily in March, 2022, only to see the market lose even more value in the months since. On the other hand, investors who invested heavily in March, 2020 have almost doubled their money.

Think Long Term

The best way forward is typically to make a plan and stick to it. If your investing strategy calls for a heavier mix of stocks than you currently hold, it might be wise to rebalance your portfolio away from cash and credit and back toward equities. Investors with years ahead of them will have the time to recover from current volatility. Investors who need their money sooner likely have a strategy that calls for fewer equities for exactly that reason.

This is the approach that the markets appear to be taking. Despite strong equity prices in 2021, money market funds gained value. Now investors appear to be rebalancing their portfolios back toward long-term asset mixes. That’s often the best advice anyone can give you: When it comes to your money, make a long term plan and stick with it.

The Bottom Line

After surprising growth during 2021’s bull market, money market funds have lost value in the downturn of 2022. Instead, investors appear to be rebalancing their portfolios toward stocks.

Tips for Investing 

We used the term “money market fund” a lot in this piece, but if you’re like most retail investors you might not know what that means. Let’s unpack it for you.

So, what should you do? Our advice is to get some advice. With SmartAsset’s matching tool, you can find a financial professional near you to discuss strategy, execution and much more. We can teach you about the market, but they can help you use it. Find a financial advisor for free right now.

Photo credit: ©iStock.com/kate_sept2004, ©iStock.com/metamorworks

The post Investors Are Moving Out of Money Market Funds and Into Stocks — Should You? appeared first on SmartAsset Blog.

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