Will You Be OK If Your Bank "Fails"?

If you haven't heard, a major West Coast bank IndyMac has been taken over by the government. There has been a small panic as many customers made a "run" on the bank--meaning they withdrew large amounts of money at once. Most banks cannot sustain such a large withdrawal amount over a small time period.

Not long ago, when banks failed, they went away. In today's age, the government tries to stem public panic by taking over the bank when it fails. Usually the FDIC (Federal Deposit Insurance Corporation) sends officials to assume the roles of executives (like CEO, CFO, etc) until the government can find another bank to purchase the assets of the failed bank.

You may be familiar with the FDIC--this is a government-run insurance corporation. Usually they have a sticker on the outside of your local bank, assuring that your accounts are insured up to at least $100,000. If you have an IRA (Individual Retirement Account) the government bumps it up to $250,000. There is also a lesser-known SIPC (Securities Investor Protection Corporation) which insures any stocks, bonds, CDs, etc up to $500,000.

So what does all that mean to you? Well..

It's time for this weeks episode of 'What Do We Learn'?

SCENARIO 1
Let's say you have $400,000 in cash in one account at JustTrustUs (JTU) Bank. If you're a regular reader here I don't know why you'd do that, but follow me. If JTU fails and is taken over by the government, how much money would you get back?

If you got the same deal the IndyMac customers got, you'd get $100,000 + 50% of the balance--in other words $100,000+($400,000-$100,000)*0.5 = $250,000. So you won't be starving, but you'll be out $150,000, which is nothing to sneeze at.


SCENARIO 2
Let's say that instead you take your $400,000 in cash and take half of it out of JTU bank and you deposit it into GiveusSome (GUS) Bank across the street. Now you have $200,000 each in JTU and GUS. Now what happens?

If only one bank fails (JTU):
JTU (failed) will give you 100K + (200K-100K)*0.5 = 150K
GUS (OK) will still have: 200K
You now have 350K!

If both fail:
You'd have 300K (through similar math).

So basically, you save 50-100K of your money by simply splitting. Not bad, but you can see where we are going here. If you have large amounts of cash and don't want to invest it, never have more than 100K in one account in one bank. Spread the wealth across several banks. With securities that you have invested, you should talk to your account holder about splitting the account if you are worried that it will fail --but be assured that established national companies most likely (emphasis on most likely) will not fail.

What do we learn?
- Never keep more than $100,000 in cash in one bank.
- Be cautious when keeping millions of dollars in one mutual fund or IRA.
- And if you have significantly less than 100K, let alone in one bank..relax, you're insured.

We Aren't Marketing Slaves...

When it comes to reasons why people chose spending themselves into oblivion over saving and investing, you often hear two compelling and popular excuses er, suggestions :

The first falls along the line of the "Livin' La Vida Loca" and appeals to the younger crowd. The premise is that you shouldn't be saving in your 20s because you have "your whole life" to save. Furthermore, you shouldn't save because Life Isn't about Money, and You Can't Take it With You. I actually can respect this argument because the person has at least established that they don't care about long-term goals (money-wise at least). But it's a bit of a strawman argument--just because you save for the future doesn't mean you can't "have fun." and when you think about it, you don't really have to spend a lot of money to have fun anyway.

It's the second, more academic argument I have a problem with: the Addiction argument. It's the one that bases our tendency to spend all of what we make (and beyond) on the premise that we are "bombarded" with marketing, and as a result, are conditioned to spend, spend, spend. We see rich people on TV, our neighbors next door, our friends' possessions, and we want what they want. So we are "conditioned" to continually purchase things against our will and our budgets suffer as a result.

The problem with both of these arguments is that they seem to encourage people to shirk their own personal responsibility--the La Vida Loca argument suggests that you shouldn't worry about the future because "anything can happen," and the second argument basically says you can't help yourself--that we are slaves to marketing. Both eventually lead to dependence on the Government later in life, an entity will of course, turn to citizens to subsidize the results of these behaviors through higher tax rates to fund entitlement programs.

The solution? Well, I don't see tax rates going down in the future, no matter what the talking heads and politicians on TV say. Programs like Medicare and Social Security will probably be around and will claim a larger share of our nation's production. So, if you still can, it's probably best to divert some of your funds into a Roth IRA, which taxes the money before you invest it, so that upon retirement you can withdraw the funds completely tax free. Also, learn as much about planning your financial future as early as you can. However, don't become obsessed with your financial planning--or you may do more damage than good. Many times people dedicate large amounts of their day with their eye on their fund and may move it around with every market fluctuation and will lose out over the long term.

Finally--remember you are a human being and not a machine. You have control over your purchasing decisions, and as a grown up are equipped with the ability to reason. You have power over still and moving images encouraging you to buy things. You are not a slave with uncontrollable buying habits and if you think you are, its time to re-think that and simply dedicate yourself to bring your buying power and decisions back under control. Now, if you'll excuse me, I will get off this dusty soapbox and watch the ad-supported, corporate sponsored Lakers-Celtics basketball game in peace.

Bankrate: 12 "Necessities" That Drain Your Budget

Here is an insightful article from Bankrate.com about 12 "necessities" that can drain your budget. I've shortened the list and will comment on a select few. Back in the day, "necessities" covered things that were necessary (hence the term) like food, water, and shelter. Yet, in these touch economic times people tend to place necessary value on things like:

1. Daily latte/coffee (bought from a coffee shop)
2. Cable TV
3. Manicures/Pedicures
4. Botox
5. Bottled Water
6. Second Car
7. Lawn Service
8. (Expensive) Clothes
9. Childhood Parties
10. Cell Phone
11. Private School
12. Pet Grooming


Comments:

1. I don't get the whole coffee thing, let along getting it every day. Is it the ambiance people are paying for? It's just coffee, and I bet you could get it for cheaper by (as Bankrate suggests) making it at home.

2. I have cable TV and DVR and would probably be the first thing to go if I had to make serious budget pare-backs. That could easily save you 1,000 per year easy.

4. Who thinks botox is a necessity? This is definitely the "outlier" on the list if you ask me.

5. Bottled water isn't what it's all cracked up to be. As mentioned in the article, tap water isn't all that bad, especially if you buy a filter of some sort. Just because water is in a bottle doesn't mean its any cleaner/better. I agree with them here.

10. My cell phone plan is fairly affordable, and its the only phone I have. I haven't had a land line in over 5 years. Yikes, it's scary how long it's been. I'm rarely home except in the evenings, so it usually works out. However, with these "get everything for $99" plans I see now, I still think premium cell phone service is overpriced.

I don't have kids yet, no pets, no car, and no lawn. Those things will come, but I think the theory of look for smart options should be your guide here. Instead of private schools, consider Charter Schools or Magnet Schools which are (usually) better-performing and in most cases, free. And besides, you're already paying for public school, just look for a quality one. As for those other things, I'll speak on them when I have more experience with them. Perhaps readers with children can shed some light.

Spending More Makes You Feel Good?

So I saw this on CNN recently:

Researchers in California have uncovered that Americans are more satisfied by a wine's taste if they "know" it's more expensive. Antonio Rangel, associate professor of economics at the California Institute of Technology, has analyzed the reactions of 21 volunteers who were presented 15 wines in a random manner, the only information being the price.

Unbeknownst to them, two of the wines were repeated, but presented with different price tags. The researchers also carefully observed changes in a part of the brain known as the medial orbitofrontal cortex, which plays a central role in many types of pleasure.

They found out that test subjects were more pleased by the taste of wines they thought were expensive.

Well, there you go. Although the sample size in this study was small, I still think it is an important study. This is not dissimilar to the not-as-scientific study performed by the libertarian comedians Penn and Teller, who tried to see how patrons reacted in an upscale, high-end restaurant when they were served very cheaply-prepared food. See the clip in my September article here. But wait! There’s more:

As part of the test, a pricey $90 wine was provided marked with its real price and again marked $10, while another wine was presented at its real price of $5 and also marked with a $45 price tag. In both cases, the volunteers thought that the wine was better when the higher price tag was presented.

This should be no secret to most people; however, most consumers still fall prey to it because they are convinced that more expensive products are “better” and “cheaper” is somehow less in quality. For consumer goods, not just wine, this is just false. But why do people behave this way? From the study:

The results showed that the way in which the brain works is that it mixes pleasure with expectation as to how good the wine should be. Since the expensive wine was supposed to be better, their brains perceived it as the superior drink.

This means that no matter how good a cheap wine may taste, consumers will still likely buy the more expensive wine and believe it tates better.

Again, not all that surprising. But it’s usually the “well duh” stuff that trips up the average consumer in restaurants, in the electronics store, the grocery aisle, and even the car salesman’s lot. I’ve had countless people try to justify why one particular shoe “wears better,” how no mp3 player’s sound quality can rival the iPod, or the name brand grape soda taste better than the store brand. To be fair, sometimes these conclusions are true, usually though its hard to objectively prove. Marketing departments at major companies know this, and it usually works in their favor. People buy more expensive goods with the expectation (feeling) that it should be better, and their brain’s logic center loses out and confirms this “feeling.”

There are times though, when it doesn’t work. Witness the sales race between the PlayStation 3, Microsoft’s Xbox 360, and Nintendo’s Wii. On paper, the PS3 looks as if it should be “better” by a long run, and it is of course more expensive. The same occurs for the Xbox 360. The consumer market however, bucked the trend and opted for the cheaper Wii, and demand continues to outpace supply for the device.

But let this be a warning that you should always consider—never underestimate the power of marketing, and don’t ever think that paying more for something makes it better. Moving forward, you should be aware (and more careful) of your spending decisions.

Discuss: Let's Fix Taxes this Week!

So this week I participated in a blog and the issue of how to fix the tax code came up. My answers appear with the questions below (with links for taxes you may not have known about) and I would like to open it up to you readers. If you were the tax guru and had the opportunity to fix the tax code, how would you do it? Use the questions below as your guide. I'd love to hear your opinions. (And you don't have to answer every question if you don't want to).

- Would you retain a progressive system or switch to a flat tax?
Flat tax. Hands down. It would involve no altering of the Constitution (like the Fair Tax requires). I would put forward a "20-20" plan, I would exempt the first $20,000 from any tax, then tax each dollar above that amount by 20%. I would also raise the interest income to 20% as well (currently it sits at 15%), so no matter where you make money, it's taxed at 20%. It would bring a steady flow in, and even if you live off your interest (meaning you don't pull an income), you would be taxed at 20%. Sounds fair to me.

- Would you decrease income tax and increase usage (eg, gas) taxes?
Sure. I know Libertarians suggest this all the time. They tend to follow a "legalize it and tax it" approach to things like prostitution and marijuana. I'm not a Libertarian, but I don't think it's a bad idea. If red states like Nevada and Colorado don't have a problem with it, I don't see it as a major issue.

- Would you alter our withholding system so employees keep more money until taxes are due?
No. the reason why it was put in place to begin with is because as a whole we tend to spend what we make. Some people are convinced that "they don't even pay taxes, because the government pays them," when actually they are getting a refund. Withholding enforces the idea of "out-of-sight, out of mind," and keeps people from going into bankruptcy when they get a $7500 tax bill in April.

Would you tie the AMT to inflation, scrap it, or leave it?
Scrap. AMT (Alternative Minimum Tax) was an envy tax, and now everyone is getting bitten. Let the government find a way to budget properly and cut spending, like the rest of us do.

Would you change SS (Social Security) and Medicare payroll tax rates? Change the SS cap? I might leave it the same, but I just don't feel as if I'm getting any SS anyway. SS is supposed to go under in 2042, just when I turn 62 and can start to claim benefits. Knowing that I probably won't get any return on my "insurance investment" will probably make me more reluctant to raise the cap on how much more of my hard-earned paycheck they can take.

- Would you (continue to) promote saving and investment through tax policy? Home owning?
You know it! Saving is very important, and we need to convince future Americans to save like their grandparents did, to have a supplement for Social Security. And I would favor responsible home-owning and discourage giving out loans to people who cannot pay them (like we see in the risky sub-prime market).

- Would you permit taxpayers to target a portion of their payment towards specific programs?Not a bad idea, as long as it's properly regulated. I wouldn't want people to cheat the system by having John Smith donating to the "Smith Family Empowerment Fund." However, it would be interesting to direct your tax funding to a certain government department (education, energy, defense, etc.)

- Would you change the child tax credit? Change rates for married filing jointly? Nah, I'm not heartless. The EITC and Child Tax Credit is helpful to families who need a little help sometimes. I would extend this. If you're married filing jointly, I would not penalize you for this either.

Would you eliminate the gift tax? The inheritance ("death") tax? To compromise, I would bring both down to the flat tax rate of 20%. 55% is kinda harsh. I agree money can be taxed "every time it changes hands," but we should be reasonable, so that we won't have an AMT-type problem in the future.

-Would you tinker with the rates for different brackets? With what goal in mind? See first answer above. My goal is to help educate people that they are funding the government and they should keep an eye on how their money is being spent in Washington.

Now it's your turn. Discuss!

Good Advice, Bad Advice.

The Financial Markets took it on the chin this week. However, while everyone around you is in full panic, it's important to keep your head. Those of you in our year-long Stock Market game (it's still not to late to jump on in), probably have experienced first hand the perils of day-to-day monitoring and trading in such a volatile market. This CNN Finance article provides some sound insight on the importance of investing a few nuggets, especially for you who hold 401(k) portfolios:

Fluctuations in the market shouldn't get to the 401(k) investor. Keep in mind your time horizon - most of us are going to be invested in the market until we retire, often decades from now.

On average, stocks move higher - their long term average gain is 10.8 percent each year, according to Hugh Johnson of Johnson Illington Advisors.

Over those long time horizons, stocks will move up and down. It will be nearly impossible for you to call the highs and lows. If you sell now, you run the risk of missing gains and paying fees to re-invest in the market.

Here's an example of how damaging moving your money around can be:

If you sold your stocks at the market bottom in September of 1998 when the Dow was at 7539.07, you would have missed out on portfolio gains of 21.8 percent by the end of that year.

Amen to that. Main point here--trust the long-term returns of the market, and shun the emotion to sell off your investments, especially if you have established, blue chip companies or sound value stocks in your folder.


ON the flip side:

Sometimes, conventional wisdom and common sense coincide. The problem is, people often times cannot find this part of the Venn Diagram of Realistic Thinking. This young unfortunate soul, who actually works for a company that gives out investment advice (although he apparently was not hired on much merit) encourages shunning Personal Responsibility and instead bumming off of your friends, family, and Credit Card companies.

No really--I'm not kidding:
To wit:

What happens if your car breaks down and you need money to get it running again? What happens if you lose your job and need to support yourself? What happens if you get arrested and need to bail yourself out of jail?

If you get in trouble and need to bail yourself out, the last thing you want is to spend your own money. The best way to avoid that is to make sure you can't afford to fix whatever the problem is. Young people are better positioned to pass off the cost of emergencies than any other group...

Every financial hardship is an opportunity -- an opportunity for your parents to show you how much they love you. Nobody's going to label you a parasite if you ask for help when you're in trouble -- that's the beauty of it.

Yikes!

If you're wondering what Estate this sheltered young man came from, understand that he is a Harvard Grad. (Not the common-sense Harvard Grad, but the stodgy, trust-fund, stereotypical kind you see on TV.)

So what do you guys think? Am I misjudging here? Perhaps up is down, and bad advice is the new good advice (and vice-versa). I'm sticking with my guns, and hoping this guy is just trying to build an audience to give real advice. Let me know if I'm missing something.

Also, what more would you like to see from our site?

See you next week.