Friday, January 22, 2010

The Small and Medium Bank Quiet Revolt: What to Consider

I first ignored the small-bank movement because I thought it sounded weird. But after doing a little research, it sounded compelling. The whole idea is based on "people-powered" (read: populist) regulation of the Too Big to Fail (TBTF) banks. It encourages consumers to move their money from these large, risky banks to smaller community banks and credit unions who invest with the local community. Who can argue with that?

So I sat down and considered all that had to happen to make this a possibility for me. And it's a pain to do. Think about all the things you have in the typical checking account: your paychecks and refunds, and other "income" are linked to this account. You have online billpay for all your "outgo" spending. Your PayPal, Amazon, and other store accounts, credit cards etc., are all connected to your account.

However, banks are getting more and more annoying. You get charged fees out the wazoo for withdrawing money from the wrong place (like other ATMs), paying money in the wrong place (like international payment fees), drawing out too much money, etc. Also, many banks (especially the TBTF Guys) tend to engage in mean practices to extort as much money as it can from its customers. For instance, some banks like to screw over smaller customers with balances close to overdrafting by debiting larger transactions to draw them in the red, then processing the smaller charges one-by-one to build up overdraft fees. The industry is indeed shady; and it may not need to be taken over, but you need to protect yourself.

Plus, there are other, intangible benefits you can experience by going local: banks offer something big banks find nearly impossible to compete with -- local ownership and the ability to talk with a familiar face in the event of unexpected financial hardship, said Tyson of the community bankers group....

Here's a link to Move Your Money, a site that will help you identify area banks with a grade of "B" or better with respect to financial strength and customer service. I'm not advocating you make that jump just yet. I haven't. But it's a good way to start the research that I'm doing. But you should also ask yourself these questions.

What Values Matter to Me?
It may seem strange to consider, but you should try to find a bank that can align with your values. Do you want a banker you can talk to when you get in a tough spot? Or do you value the "long-distance relationship" where everything is done online? Remember--you may need a loan for a car or home one day, and better rates are given to the well-known customers.

What are the Fees Like?.
Some banks like to lure you in with a free "X" but it's only for a few months. Then you can get gouged on the back end with loads of fees for minimum balances, checks written, ATM withdrawals, etc. think about how many hand-written checks you write per month how often you withdraw from ATMs, and where. Just walk into the bank, and tell them you're interested in opening an account, and ask for a fee schedule for various accounts. Some will hand it over, others won't. Its important to track down the schedule of fees for banks to find the right fit for you.

Go Slow
Finally, if you decide to make the transition, do it at your own pace. I suggest opening an account at your small/medium new bank (or banks) and begin transferring funds and switching accounts a few at a time. Maybe start with the online shopping ones. Once you get the rhythm, you can move a little more money a few more accounts. Perhaps you can draw your TBTF Bank's Account down to the required minimum funds (if they have one) and leave it there. Then go to your HR department and redirect your deposits to your new bank.

And enjoy the peace of mind!

Or something. I'm just beginning to do my research and plan to move. We'll see what happens, and I'll keep you posted.

Sunday, November 15, 2009

Next Year’s Roth IRA Loophole: Get In If You Fit In?

We’ll start with a question: when you retire, do you think you’ll be in a higher tax bracket or a lower tax bracket when you quit your job? Let me explain why this question is important. If you have and regularly contribute to a 401(k) or IRA, you are storing money away pre-tax—which means you get to store away some savings from your gross pay, and then Uncle Sam comes and gets his cut. So you’re earning interest on untaxed money. Then at retirement, whichever tax bracket you ended up in is where you will be taxed as you make withdrawals from your account.

In a Roth IRA/401(k), the government gets his cut first, and then you get to save off of the remainder. But at retirement, you get to take out as much money as you want as often as you want without the money being taxed. So generally, if you expect to be in a higher tax bracket in your last few years of work, the Roth IRA is for you.

The problem, however, is that Roth IRAs are subject a several limits. From Reuters:

Only taxpayers who earn less than $105,000 ($166,000 for joint filers) in 2009 can contribute the maximum amount ($5,000 per person, with a $1,000 additional catch up contribution for folks 50 or older) to a Roth IRA. And only people earning less than $100,000, single or married filing jointly, can convert their traditional IRAs to Roths.

That would probably qualify all but a few of you. However, for you unlucky few who are in the upper echelon, that income limit will disappear next year...for one year. You will have to pay taxes on the rollover however, and depending on the size of the nest egg you’re rolling over, you’ll need a pretty significant cash reserve to cover it. For instance, if you have $40,000 in an IRA and fall in the 25% tax bracket, you’d owe $10,000 to the government to switching. So if you can afford it, go for it!

I won’t spoil anymore for the article (and besides, I’m not there yet). But I think you should give the whole article a read. They include other factors to consider if you think about making the switch.

Wednesday, November 04, 2009

Mutual Fund Fee Lawsuit Heads toward Supreme Court

Here’s a story that caught my attention as an investor:

Nov. 2 (Bloomberg) -- John Bogle helped create a mutual-fund industry that has grown to $10 trillion in assets. Now the Vanguard Group Inc. founder is backing investors asking the U.S. Supreme Court to limit the fees charged by fund managers…
The dispute pits the fund industry against trial lawyers, consumer-rights groups and Bogle, an industry pioneer who started Vanguard in 1974. Bogle, who filed a brief supporting the Oakmark investors, says mutual fund shareholders are being overcharged with fees that seem low when expressed as percentages yet add up to a multibillion-dollar windfall for advisers.

Emphasis on the last sentence mine. So let’s unpack this. It’s no secret that the mutual fund companies charge high fees for managing their funds. Called an expensive ratio, it’s the management fee the company charges for “taking care of your money.” The article is right that these companies take up to 1.5%, some more, of your returns (or lack of returns) as a fee.

This demands a closer look. Let’s say the S&P 500 returns 5% this year. If a mutual fund company gains you 6%, (1% above the market from your investment over last year) they will deduct 1.5% of it leaving you with and effective 4.5% return. If they LOSE 6%, they STILL deduct 1.5%, leaving you with a 7.5% loss. And don’t forget that “stellar” track record that actively managed mutual funds have. But “what difference does 1% or so make over the long term?” you may ask. After all, you get to keep the other 99%, right? Well:
Assume that you are an employee with 35 years until retirement and a current 401(k) account balance of $25,000. If returns on investments in your account over the next 35 years average 7 percent and fees and expenses reduce your average returns by 0.5 percent, your account balance will grow to $227,000 at retirement, even if there are no further contributions to your account. If fees and expenses are 1.5 percent, however, your account balance will grow to only $163,000. The 1 percent difference in fees and expenses would reduce your account balance at retirement by 28 percent.

This is what the plaintiffs are fighting against. I’m a bit unsure of what they want to happen (certainly they don’t want the feds setting profit rates). I think there is still a large enough amount of mutual fund companies out there where consumers can shop around for a balance of cost and service.