Smart401k Blog

The ongoing market turmoil has generated a number of questions from our clients regarding the safety of their account. I thought I would take the time to discuss various accounts and what kind of protection each offers.

FDIC

Bank deposits are insured through the FDIC. The Federal Deposit Insurance Corporation insures deposits in banks and thrift institutions for up to $100,000 per person, per insured bank. This covers savings accounts, checking accounts and certificate of deposits (CDs). There are several ways that allow customers to increase their protection beyond $100,000. Some of these include the following:

• Brokered CDs - A brokered CD is a certificate of deposit purchased through your brokerage firm that places the money with an issuing bank. Purchasing multiple CDs through your brokerage firm allows you to spread your money across several institutions capturing the full FDIC protection at each institution.
• Payable on Death accounts (POD) - POD accounts are bank deposit accounts that are set up with multiple beneficiaries. For each qualified beneficiary, the account holder’s FDIC coverage increases by $100,000. The beneficiary has no rights to the funds until the account holder passes. The only real drawback to a POD bank account is that you cannot name alternate beneficiaries on one account.
• Joint accounts - Deposit accounts owned by more than one person are insured up to $100,000 per account holder.
• Multiple institutions - Customers that open deposit accounts at more than one bank are eligible for full FDIC protection at each bank
• Individual Retirement Accounts (IRAs) that are invested in a certificate of deposit also fall under FDIC protection. However, CDs held in IRAs are insured up to $250,000.

Editors Note:  Since this blog was posted, the FDIC coverage limit has increased. Today the FDIC covers $250,000 per depositor, per insured bank.  To learn more, go to http://www.fdic.gov/deposit/Deposits/insured/basics.html

SIPC

Brokerage accounts are covered by the Securities Investor Protection Corporation. When a brokerage is closed due to bankruptcy or other financial difficulties and customer assets are missing, the SIPC steps in and, within certain limits, works to return customers’ cash, stock and other securities.

The SIPC covers up to a maximum of $500,000 including up to $100,000 for any cash claims.

For example: Investor John Doe has an account with Brokerage A that declares bankruptcy. John has $800,000 in his account prior to the bankruptcy with $125,000 of his balance in cash. SIPC would cover $500,000 with $275,000 in securities and $25,000 in cash not being covered.

Retirement Accounts

Retirement accounts, including 401(k)’s and variable annuities, are protected in the event of a bankruptcy through the use of trusts, a legal instrument that spells out the beneficiaries and what the money can be spent for, which are shielded from bankruptcy creditors should their account provider run into financial trouble.

I hope this clears up any questions you might have, but as always, feel free to contact us by email at info@smart401k.com  or by phone at 877.627.8401 if you’d like to discuss this topic or any others directly with an advisor.

Buck Wendel, Investment Advisor

P.S. As you know, a large part of our day is staying abreast of the market.  This includes learning more about what other money managers are thinking.  Below is a quote from a recent market overview written by Bob Doll, Chief Investment Officer of Equities, at BlackRock, a large asset manager.  This information is provided to show another perspective on the market and is not intended to be interpreted as advice or a forecast of the markets.

” The broad sell-off in equity markets that we saw two weeks ago and again yesterday are, in our opinion, signs of capitulation on the part of many investors. Risk tolerance has moved to extremely low levels and we have seen a large degree of high-volume selling. Over the short term, these tend to be signals that the market is due for a rally. Volatility measures also point to the possibility of some sort of short-term climb in equity prices. Yesterday, the VIX Index (a measure of stock market volatility) rose into the upper 40s, a place it has only been four other times in its history- during the Asian financial crisis of the late 1990s, the Long-Term Capital Management fallout, the 9/11 terrorist attacks and the WorldCom bankruptcy filing. Following those previous VIX spikes, the S&P 500® Index climbed an average of 7% one week later, 11% one month later and 15% three months later. This is admittedly an unscientific sample of only four events, but, combined with the other factors we mentioned, we do believe it signals a high probability of a market rally. ”

Click here to read the rest of the article

In the headlines

A look at some of the market movers over the past week:

• The government’s proposed $700 billion bail-out hit some roadblocks, but went into the weekend showing renewed progress
• Goldman Sachs (NYSE: GS) and Morgan Stanley (NYSE: MS) announced plans to become traditional banks
• Japan’s Nomura (NYSE: NMR) agreed to purchase the Asia assets of Lehman Brothers
• Federal Reserve Chairman Ben Bernanke spent the first two days of the week testifying before Congress about the $700 billion bail-out plan
• Warren Buffett’s Berkshire Hathaway (NYSE: BRK-A) announced a $5 billion investment in Goldman Sachs
• The FBI started an investigation into some of the companies that have recently crashed, including Lehman Brothers and AIG (NYSE: AIG)
• US home values continue to fall
• The eurozone disclosed a second consecutive quarter of GDP contraction earning them the “recession” label
• General Electric’s (NYSE: GE) finance division made sure that even GE hasn’t missed out on financial losses
• Washington Mutual (NYSE: WM) became the largest bank failure in US history
• Delta (NYSE: DAL) and Northwest (NYSE: NWA) shareholders approved merger plans that would create the largest airline in the world

Commentary

After a major display of stock market fireworks last week, the week started off with continued volatility. By Wednesday, the S&P 500 index had shed 5.5%. Though it was able to recover some ground on Thursday and Friday, the index still lost over 3% on the week.

We really didn’t have to look too far to figure out what caused all of the week’s volatility. The US Treasury Department, with the support of Ben Bernanke and the Federal Reserve, has presented a plan to use $700 billion from the Treasury to buy distressed mortgage and other credit assets from the US’s financial institutions. The idea of the plan is to provide a buyer and a source of pricing for what have become very illiquid assets.

This would hopefully allow financial institutions to shore up their balance sheets and begin lending again. At the same time, it is hoped that the distressed pricing that the government would be paying would allow it to collect anywhere from a major portion to even more than the original $700 billion outlay.

Despite the endorsements from Treasury Secretary Henry Paulson, Fed chief Bernanke, President Bush, and many prominent Democrats in Congress, a group of Republican Congress members expressed concerns late in the week and brought negotiations to a near standstill. The market meanwhile has been reacting primarily to the potential for these negotiations to continue and for a deal to be struck in the near term. Though there wasn’t a lot of clarity going into the weekend, negotiations seemed to at least be moving in the right direction.

Though the news of the Washington Mutual failure wasn’t lost in the shuffle, the announcement likely had little impact on investors’ sentiment. There were a few reasons for this. First, though the collapse of the bank was a clear negative, the fact that JPMorgan (NYSE: JPM) stepped in to buy the deposits and saved the FDIC from digging into its pockets was a bit of a balancing factor. It is also likely that investors were not particularly surprised by the collapse, as the bank and its stock have been struggling for some time now. In addition, investors hoping for a government deal to be struck may have seen this as an event that would make the passage of a plan even more urgent.

And finally, the $5 billion investment that Berkshire Hathaway made in Goldman Sachs may not have been ultimately as significant as the failure of Washington Mutual, but investors were clearly cheered by the news. In the face of a great deal of negativity though, it may not be surprising that a vote of confidence like this in a US financial institution by Warren Buffett — widely regarded as one of history’s greatest investors — would cheer the markets.

Looking ahead

As the month of September pulls to a close, we can look forward to a variety of important economic reports next week. Personal income and personal spending come out early in the week, as does The Conference Board’s reading on consumer confidence. Later in the week, though, we’ll also see the much more notable reading on unemployment.

Though Tuesday will mark the end of the third calendar quarter, third quarter earnings season won’t kick off until the following week, when Alcoa (NYSE: AA) reports results on October 7th. Despite the lack of formal earnings reports, though, we may end up seeing companies that are closing their books for the quarter start to inform investors of quarterly shortfalls.

But let’s get real, all the market cares about right now is the government’s bail-out package. It seems that a good deal of important recent news events have been taking place over weekends, so I wouldn’t rule out something happening before the beginning of next week. If it does not, though, we can fully expect that the market will continue to move in accordance with the perceived likelihood of a plan being passed, and being passed soon.

But should we be rooting for such a plan? I believe we should. When somebody is sick and suffering from an extreme fever, the first step to treating the patient is to bring down the fever so that you can treat the underlying illness without the patient dying. Right now the trouble in the financial sector of the economy is a very dangerous fever, and one that needs to be addressed before we do anything else.

In my opinion, though, the good news is that while the underlying economy may be sick, it’s far from broken and if we are able to quickly address the issues in the financial system we should be able to find our way back on track.

I thought you all might be interested to hear Adam Bold’s, Founder and CIO of Smart401k and The Mutual Fund Store, outlook on the market.  He provided it on the most recent airing of “The Mutual Fund Show” his weekly call-in radio show.  

Here’s a link to the excerpt.  There’s about a minute to a minute and half of diclosures/introductions before his commentary, but after that he dives right in.

Scott H

In the headlines

A look at some of the market movers over the past week:

• Lehman Brothers (NYSE: LEH) filed for bankruptcy
• Bank of America (NYSE: BAC) agreed to buy Merrill Lynch (NYSE: MER)
• Oil dipped below $100 per barrel
• Hewlett-Packard (NYSE: HPQ) announced nearly 25,000 layoffs
• The Federal Reserve bailed out insurer AIG (NYSE: AIG)
• Barclay’s (NYSE: BCS) agreed to buy Lehman’s investment banking unit and its New York headquarters
• The Federal Reserve decided to keep rates steady at 2%
• Morgan Stanley (NYSE: MS) and Wachovia (NYSE: WB) entered preliminary merger talks
• Markets soared on news that the US government is working on a plan to help out the ailing US financial system
• The Securities and Exchange Commission decided to halt short selling on 799 financial stocks

Commentary

I take a vacation for one lousy week and look what happens! While there certainly was a lot more going on that what I’ve listed above, the events listed far and away dominated both the headlines and the headspace of investors over the past week.

By the end of the week, the S&P 500 index closed out with a small 0.3% gain from the previous week — but what a wild ride it was to get to that end result. Monday and Wednesday both delivered 4.7% losses on the S&P, and by the close on Wednesday the market had shed an incredible 7.6%. In the final two days of the week, though, the index rallied an even more incredible 8.5% leaving behind the small gain that we ended with.

When all the dust had settled, we had a week to look back on where the market moved 4% or more in four of the five trading days. To find another week to compare this to we have to turn all the way back to the week of October 19th of 1987 when the markets took their historic one day plunge and then spiked back up 15% in the following two days. With that as a point of comparison, we can bet that this will be a week long remembered in the world of finance.

As I said, there was much more going on over the past week than the list above gives due. However, we can really attribute the explosion of volatility to four major events — the bankruptcy of Lehman Brothers, the buyout of Merrill Lynch, the bailout of AIG, and the government’s latest attempt at intervention. The first three events put a massive underscore and exclamation point on the financial troubles that have been shaking the US and caused the government to bail out Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) only a week earlier. Not only did the events signal that the turmoil isn’t over, but the bankruptcy filing by Lehman suggested that the government wasn’t going to be around to bail out every financial giant facing disaster.

The final event, though, the US government’s plan to rescue the financial system, rallied the markets like they’ve been rallied few times in the last half century or more. Since we’re discussing the market impact of the plan here, and not the political ramifications, I can simply say that the implementation of systematic purchasing of struggling financial assets by the government would create a solid backstop for financial companies and help arrest the potential panic that might have unfolded if current conditions continued unchecked. It was also a big turnaround from the Lehman bankruptcy filing earlier in the week, showing that the government is, in fact, armed and ready to do what it thinks needs to be done to shore up the US financial markets.

An evaluation of the economic impact of the government’s plan can’t really begin until the plan is laid out in full. And even then it may be difficult to gauge what such a huge and unprecedented program may lead to — for good or bad.

Looking ahead

If the outlook for the future ever had so much as a glint of certainty in recent times, that has been absolutely blown out of the water. Yet-unfolding events and underlying economic conditions have conspired to produce an action packed past week — to say the least. Looking ahead, not only do we have the specter of further true dislocation, but we can surely expect that investors will be on a hair trigger — buying and selling in big swings on the least sniff of big news.

Next week will no doubt be dominated by news covering the emerging details of the government’s bailout of the financial system, along with related developments in the financial sector. A light economic calendar and few notable earnings reports will only make the spotlight on the government bailout brighter.

As Monday and Wednesday of this past week reminded us, calling a market bottom can be a dangerous game. But with Thursday and Friday came a refresher course in why panic selling is not a good choice either. In fact, the rocky week we just experienced gives me yet another opportunity to hammer home the point that tracking the market on a day-to-day basis can often be not only a waste of time, but a huge emotional and financial drain. As a long term investor, your goal is to take advantage of the big five, ten, and twenty year moves in the market, not the comparatively small-fry swings in daily trading — no matter how jarring they may be.

This does mean that you will have money in the market when it declines, and it will sometimes mean that you will add to your investments at what, in retrospect, seems inopportune times. However, it also means that you will more likely than not also add to your investments at some incredibly timely moments. In times like the present it’s particularly important to remember this rather than get caught in the timing trap that many individual investors do.

Specifically, many investors invest heavily and happily when times are good — when it’s easy to invest. If they have held on this long through the current downturn, the beginning of this past week may well have shaken them out, finally causing them to throw up their arms and swear off the stock market altogether as too risky. Many of these same investors, however, will end up watching the market charge back up when the next bull market starts and eventually — say, two to three years into the bull market — will decide it’s safe to get back into stocks. For many of them this will mean that they will have sold at or near the bottom only to buy back in at or near the new top. I can promise you that this will make the process of building a retirement nest egg only more challenging.

Investors that hang on through the whole cycle will certainly not be able to boast prescient market timing skills, but they will no doubt outperform the hapless investors described above by a wide margin. At the same time, by keeping the big picture in view, they will also avoid the ulcers and indigestion that the other group will see in spades.

It would be a mistake to say that the financial markets and the underlying economy aren’t facing tough times. But it would likewise be a mistake to abandon diversified equity investing now. The US and global economy continues to grow and prosper, and though this won’t be the last bump in the road, it also shouldn’t be your exit point as an investor.

Age 3-5:

At this age, I’m not going to try too much; I just want him to be aware of what money is and what it’s used for.  Perhaps my first rule will be:  Don’t eat the money (I never underestimate his curiosity).  Next, I will most likely just dump some change on the floor and let him have fun sorting the money into sizes and colors.

Later in this age group, I may introduce the use of money by letting him put coins into a vending machine or hand money to a cashier at the store.

Age 6-10: 

By now, he should understand the differences in the value between coins and bills and other basic money-related concepts.  Most of this is taught in schools, so I may not have to do much in this area, but I will verify that he understands it.  He should also begin to understand what things cost (e.g. a TV is more expensive than a hamburger).

Starting with this age range, I will introduce an allowance.  I believe an allowance is a good method to teach kids about spending and saving.  It will be his money and his decisions about how to use it.  I will let him make mistakes so that he learns from them.     

There seems to be some debate about whether an allowance should be earned or given freely without condition.  I don’t think there is a right or wrong answer here, but I am not going to tie chores to his allowance.  I feel that it will be his family responsibility to clean his room or help with dishes, and not a requirement to get paid each week.  I think of this “give-away” as a good investment.  If you go to a ballgame and they want to buy one of those big finger gloves, let them, as long as they use their own money.  They want a new bike?  Sure, if they put in half (doubt they will want the most expensive one now).  This not only helps them, it helps you save money.    

In order to help make the work/pay connection, at this age I will start giving him simple projects to help around the house for extra money (raking leaves, cleaning windows, etc).

The next age group (11-18) is a much bigger topic in of itself which is why I am going to end here and cover that group in its own post.

As always, if you have any comments or ideas on what has worked for you, please post them - they are greatly appreciated.

Kevin Jaegers, Senior Investment Advisor