Marketplace

Low rates on savings

Question: If credit and money is so difficult to get right now, why are savings accounts still yielding only around 2%? Why can't we savers get a better deal? I remember routinely getting 6% at our credit union years ago, but that is long gone. Retirees and near-retirees want to know. Diane, Sinking Spring, PA

Answer: While Congress, the White House, the presidential candidates, powerbrokers, scholars and others struggle to come up with a way to contain the credit crunch, the immediate concern on Main Street is more prosaic and equally consequential: Will the money my family has set aside for everything from paying for car repairs to meeting a tuition bill to paying for high blood pressure pills be there when needed? Put somewhat differently, "what is the safe harbor," asks Zvi Bodie, finance professor at Boston University.

The answer is that there are several "safe harbors." Many are fleeing into a handful of options that are essentially risk-free parking places for money. The trade-off for a no-risk to low-risk safety net is a low interest rate and a low investment return. All the savings options involve relying on U.S. government backing rather than private sector promises.

Take short-term Treasury bills. Investors from around the world have decided to seek safety in T-bills. As I am writing this, investors are willing to get paid an interest rate of a mere 0.81% in return for owning a default-free investment, the 3-month T-bill.

You can do a little bit better with money market mutual funds that invest solely in short-term Treasuries, but not by much. For instance, the yield on the Vanguard Treasury only money market mutual fund is about 1.6%. And, of course, you mentioned your savings account. Well, assuming the deposits are insured by the FDIC, no one has lost a penny since the government's bank insurance fund was established in 1933 if the accounts had less than the insured limit. It looks like Washington is moving toward raising that limit even more, perhaps to $250,000. The $100,000 limit is something of a misnomer, however. It's relatively easy to park a multiple of that sum at the same bank and still get the total insured by the FDIC.

Again, because of concerns over safety--will my money be there when I need it--banks don't have to pay you much for your savings. The rates of certificates of deposit or CDs have gone up recently, but not that much.

One other point: Despite consumer inflation up over 5% so far this year, fears of inflation are receding. Higher inflation rates can drive up interest rates. But with the U.S. economy in recession, debt imploding, and the global economy slowing down it's hard to see the over all price level climbing higher anytime soon. (Nevertheless, I am a big fan of Treasury inflation protected securities, better known as TIPS. These default-free securities protect the investor from the ravages of inflation if it does ever pick up. TIPS offer a fixed interest rate above inflation as measured by the consumer price index (CPI). The bond's principal is adjusted as the CPI changes. That said, TIPS have one drawback for safety-minded individual investors: Taxes. In essence, Uncle Sam requires owners in taxable accounts to pay income taxes on inflation-adjusted gains before getting any of inflation-adjusted money at maturity. The trick to avoiding the tax hit is to own the bonds in a tax-deferred retirement savings account.)

Today's very low interest rates are painful for many savers, especially retirees. Still, my own feeling is that the trade-off is worth it.

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10/01/08 by Chris Farrell

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Fund a 529 plan now?

Question: My son is 4.5 and I am thinking of starting a 529 plan for his college tuition (I know I am late to this). My question to you (I know it sounds dumb but I want to get it right) - is this a good time to buy a 529 plan or should I wait for sometime and wait for the markets to stabilize? Krishnan, Tallahassee FL

Answer: No, you’re not late getting started on a college savings plan. You have plenty of time on your side since your son is less than 5 years old. And no, it isn’t a dumb question to ask. A lot of people share your concern considering the Wall Street credit crunch and the global financial crisis.

That said, the big advantage of funding a 529 plan now—despite all the turmoil—is that the money will compound tax free until you need it to pay for your son’s college sheepskin. What’s more, the money can be withdrawn tax free so long as its used for qualified expenses, such as tuition. I’d get the money to work.

Now, the option I like the most is the age-based investing option. The younger the student, the higher the percentage is invested in an equity index fund and as the student ages the percentage invested in equities automatically decreases and the percentage invested in fixed income securities automatically increases. Of course, the equity portion of the portfolio is getting hammered right now. If that’s too risky an option for you, most plans offer a money market fund as well as a conservative bond fund choice.

I’d open the plan and harness the power of tax free compounding over time.

10/02/08 by Chris Farrell

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Libor

Question: I hear that Libor’s rate have gone up a lot. Is this the same Libor rate that adjustable mortgages are pegged to? Dan, Baltimore MD

Answer: Yes, many U.S. adjustable rate mortgages are pegged to the Libor rate. Indeed, it’s estimated that about half of the ARMs written in recent years were linked to Libor.

Libor is short-hand for the “London interbank offered rate”. Libor is calculated for several currencies, including in dollars. The greenback rate is set everyday before noon by data collected from 16 banks by the British Bankers’ Association. You can learn more about Libor at the BBA’s website here.

The recent surge in Libor reflects the global credit crunch. The 3-month Libor rate was trading over 5% when the first bailout bill failed to pass but it has come down close to 4% with the second attempt succeeding. Still, banks are hoarding cash, unsure when they will need the money and increasingly fearful of lending it out.

The Libor rate is critical throughout the world. It influences everything from home loans to credit cards. According to Bloomberg, Libor determines prices for financial contracts valued at $393 trillion as of Dec. 31, 2007. Breaking it down, the story calculates that’s some $60,000 for every person on the planet.

10/03/08 by Chris Farrell

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The money market mutual fund stabilization fund

Here is the press release put out by Treasury on its back-up plan for making sure that money market mutual fund money invested before September 19 doesn’t “break a buck”.

September 29, 2008 hp-1161

Treasury Announces Temporary Guarantee Program for Money Market Funds

Washington- The U.S. Treasury Department today opened its Temporary Guarantee Program for Money Market Funds. The U.S. Treasury will guarantee the share price of any publicly offered eligible money market mutual fund - both retail and institutional - that applies for and pays a fee to participate in the program.

All money market mutual funds that are regulated under Rule 2a-7 of the Investment Company Act of 1940, maintain a stable share price of $1, and are publicly offered and registered with the Securities and Exchange Commission will be eligible to participate in the program. Treasury first announced this program on Friday, September 19.

The temporary guarantee program provides coverage to shareholders for amounts that they held in participating money market funds as of the close of business on September 19, 2008. The guarantee will be triggered if a participating fund’s net asset value falls below $0.995, commonly referred to as breaking the buck.

The program is designed to address temporary dislocations in credit markets. The program will exist for an initial three month term, after which the Secretary of the Treasury will review the need and terms for extending the program. Following the initial three month term, the Secretary has the option to renew the program up to the close of business on September 18, 2009. The program will not automatically extend for the full year without the Secretary’s approval, and funds would have to renew their participation at the extension point to maintain coverage. If the Secretary chooses not to renew the program at the end of the initial three month period, the program will terminate.

To participate in the program, the Treasury Department will require money market funds with a net asset value per share greater than or equal to $0.9975 as of the close of business on September 19, 2008, to pay an upfront fee of 0.01 percent, 1 basis point, based on the number of shares outstanding on that date. Funds with net asset value per share of greater than or equal to $0.995 and below $0.9975 as of the close of business on September 19, 2008, will be required to pay an upfront fee of 0.015 percent, 1.5 basis points, based on the number of shares outstanding on that date. These fees will only cover the first three months of participation in the program.

Funds with a net asset value below $0.995 as of the close of business on September 19, 2008, may not participate in the program.

While the program protects the accounts of investors, each money market fund makes the decision to sign-up for the program. Investors cannot sign-up for the program individually. Funds should apply by October 8, 2008 for the program using the forms on the program webpage: http://www.treas.gov/offices/domestic-finance/key-initiatives/money-market-fund.shtml.

Eligible funds include both taxable and tax-exempt money market funds. The Treasury and the IRS issued guidance that confirmed that participation in the temporary guarantee program will not be treated as a federal guarantee that jeopardizes the tax-exempt treatment of payments by tax-exempt money market funds.

President George W. Bush approved the use of existing authorities by Secretary Henry M. Paulson, Jr. to make available as necessary the assets of the Exchange Stabilization Fund to guarantee the payment

The Exchange Stabilization Fund was established by the Gold Reserve Act of 1934, as amended, and has approximately $50 billion in assets. This Act authorizes the Secretary of the Treasury, with the approval of the President, “to deal in gold, foreign exchange, and other instruments of credit and securities” consistent with the obligations of the U.S. government in the International Monetary Fund to promote international financial stability. More information on the Exchange Stabilization Fund can be found at http://www.treas.gov/offices/international-affairs/esf/

And here is the FAQ: September 29, 2008 hp-1163

Frequently Asked Questions About Treasury’s Temporary Guarantee Program for Money Market Funds

How does an investor sign up to participate in the Treasury’s Temporary Guarantee Program for Money Market Funds?

While the program protects the shares of all money market fund investors as of September 19, 2008, each money market fund makes the decision to sign up for the program. Investors cannot sign up for the program individually.

How will investors know if their money market fund participates in the program?

Investors should contact their money market fund directly to determine if it is participating in the program.

What type of funds does the program cover?

All money market mutual funds that are regulated under Rule 2a-7 of the Investment Company Act of 1940, are publicly offered, are registered with the Securities and Exchange Commission and maintain a stable share price of $1 will be eligible to participate in the program. This includes both taxable and non-taxable funds.

Is an investor in a fund that is managed like a money market fund but that is not registered with the SEC covered?

No, the program only covers money market funds that are regulated under Rule 2a-7 of the Investment Company Act of 1940, are publicly offered, are registered with the Securities and Exchange Commission and maintain a stable share price of $1 will be eligible to participate in the program. This includes both taxable and non-taxable funds.

When will my fund be covered by the program?

Each fund must decide to participate in the program. If your fund participates in the program, your investment as of September 19, 2008 will be covered.

How much of an investor’s money market fund is insured? What happens if the number of shares held in an investor’s account increase above the level at the close of business on September 19, 2008? What happens if the number of shares held in an investor’s account decreases below the level at the close of business on September 19, 2008?

The program provides a guarantee based on the number of shares held at the close of business on September 19, 2008. Any increase in the number of shares held in an account after the close of business on September 19, 2008 will not be guaranteed. If the number of shares held in an account fluctuates over the period, investors will be covered for either the number of shares held as of the close of business on September 19, 2008 or the current amount, whichever is less.

Examples include:

If an investor owned 100 shares in a money market fund as of close of business September 19, 2008, but owns 50 shares on the day the guarantee payment is made, after the fund breaks the buck, then that investor will be guaranteed for 50 shares.

If an investor owned 100 shares in a money market fund as of close of business September 19, 2008, but owns 150 shares on the day the guarantee payment is made, after the fund breaks the buck, then that investor will be guaranteed for 100 shares. The fund, upon liquidation, will distribute proceeds to the shareholder for the additional 50 shares, at net asset value.

If an investor owned 100 shares in a fund as of close of business September 19, 2008, subsequently sold 50 shares and later bought 25 shares, the investor owns 75 shares on the day the guarantee payment is made and will be guaranteed for 75 shares.

If an investor owned no shares in a fund as of close of business September 19, 2008, but owns 100 shares on the day the guarantee payment is made, none of the investor’s shares are guaranteed by the program and the investor will receive the net asset value directly from the fund. What if another fund in an investor’s fund family breaks the buck before this program starts? Is the investor covered?

The program provides a guarantee on a fund-by-fund basis up to the amount of shares held as of the close of business on September 19, 2008. The performance of a different fund, even one in the same fund family of the investor’s fund, doesn’t affect the investor’s fund’s eligibility. Investors should contact their fund to determine if their fund participates in the program.

When does the program terminate?

The program is designed to address temporary dislocations in credit markets. The program will be in effect for an initial three month term, after which the Secretary of the Treasury will review the need and terms for the program and the costs to provide the coverage. The Secretary has the option to extend the program up to the close of business on September 18, 2009. In order to maintain coverage, funds would have to renew their participation in the program after each extension. If the Secretary chooses not to extend the program at the end of the initial three month period, the program will terminate.

Who provides this guarantee? Are investors able to get all of their money back whenever they want?

The U.S. Treasury Department, through the Exchange Stabilization Fund, is providing this guarantee. In the event that a participating fund breaks the buck and liquidates, a guarantee payment should be made to investors through their fund within approximately 30 days, subject to possible extensions at the discretion of the Treasury.

Is shareholder in a fund that broke the buck before September 19, 2008 covered?

No. This does not meet the program’s eligibility criteria noted above.

What should shareholders in a participating fund that breaks the buck do? Who should they call?

If your fund enrolled in the program you will be covered and do not need to take any action. Shareholders should contact their fund directly.

Who should a fund contact if it has further questions about this program?

Please e-mail the Treasury Department at moneymarketfundsguaranteeprogram@do.treas.gov.

10/04/08 by Chris Farrell

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Tax exempt bond funds

Question: Almost all of my fixed income holdings are in municipal bond funds, since my wife and I are in the 28% tax bracket. I’m wondering about the safety of municipal bonds at this time, given the current economic environment, and whether we would be better off diversifying into government short or intermediate term bond funds. Any thoughts you have about this matter would be greatly appreciated. Larry. Hurleyville, NY

Answer: The 13-month old credit crunch has taken its toll on tax exempt bond funds. The state of California is facing a cash crunch, and may need a $7 billion federal bailout. (Isn’t it amazing how we’re just tossing around the term “billions”?) New York City plans to cut its budget. States and localities across the country are dealing with declining revenues, and the fiscal situation will only worsen as the economy sinks into recession. Many economists are changing their forecasts for the economy. They’re predicting a higher unemployment rate and a lower GDP number than before. Investors are fleeing even high quality munis for the safety of U.S. Treasury securities. According to the mutual fund rating service Morningstar, muni bond funds are in the red, with the typical fund down 5.6%. Much of that decline has happened over the past year.

There is another factor haunting the market: The unthinkable is increasingly thinkable. Default rates have been low in recent decades in the state and local government tax exempt market. Yet this credit crunch has overturned many historically based rules-of-thumb. The combination of a recession and credit crunch could drive the muni default rate higher. Are muni’s less safe than recent experience would suggest?

Troubling questions like this and the worsening fiscal situation are behind some crazy moves in the market. For example, investors are pocketing a higher yield from tax-exempt money-market mutual funds than from their taxable counterparts. Normally, tax-exempt yields are lower than taxable yields, since the tax hit is so much less. Money market funds that invest only in short-term U.S. Treasuries yield about 1.5% compared to a yield of about 5% or more on tax-exempt money market funds. So an investor in the 35% federal tax bracket filing jointly and paying what the Tax Foundation calculates is an average 9.7% state and local tax burden (since the securities come from municipalities around the country) earns somewhere around a 5% yield on the tax-exempt fund compared with around 1% on the taxable money market Treasury fund. In the 28% tax bracket the taxable yield jumps to 1.08%.

What to do? I know a number of smart people who are putting some of their risk money into high-quality tax exempts, especially into tax exempt money market mutual funds (and the tax exempt money market mutual fund money that was invested before September 19 comes under the Treasury’s new stabilization fund program). These investors believe the risk is worth the reward. They are comfortable with the risk..

Your investment issue isn’t a case where I can easily tell you to “do this, but don’t do that”. Instead, here’s my advice for a portfolio issue like yours: Make sure that you’re in the conservative portion of the tax exempt universe.

It pays to stay with high quality in the municipal bond market (as well as the corporate bond market), even though yields are lower. Safety matters. That’s why diversification also pays. I like tax exempt funds that invest around the country rather than in one locality—even though that means you give up some tax advantage. The added protection is well worth the small tax hit you’ll pay.

Larry, I am a strong believer in diversifying down to the sleeping point. If you’re comfortable with your fixed income portfolio after thinking it through, fine. If you are still worried, then diversify into Treasuries—enough so that you can relax

10/06/08 by Chris Farrell

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IRA vs, student loans

Question: I currently have approx. $60,000 saved for retirement, combined between a Roth IRA (Vanguard and Raymond James) and a SIMPLE IRA (Fidelity) offered through my employer. All the money is in mutual funds like Vanguard’s Total Stock Market Index fund, energy funds, materials funds, emerging markets, small- cap, etc. My entire portfolio is down by approx 25-30% from one year ago.

Also, I have approx. $28,000 in student loan debt from my Master’s Degree. I am paying approx. 5.5% on those loans. My question is this:

Does it make sense to cease contributing to my IRAs (with negative returns) and shift that money to paying off my student loans?

or Does it make sense to keep contributing to the IRAs - with the assumption I’m buying these mutual funds “on sale”. Any advice would be greatly appreciated! Heidi. Tucson, AZ

Answer: Sorry I have taken so long to post this Q and A. I got caught up in the latest presidential debate.

Anyway, the financial environment we’re in rewards savings and penalize debt. I believe that dynamic will hold even after the global credit logjam is eased and the economy emerges from recession. The advantage of accelerating your student loan payments is that you lock in a 5.5% or so rate of return with every payment.

That said, it’s important to keep funding your SIMPLE IRA at work, especially if your employer matches your contributions (up to a limit of 3% with a SIMPLE). The real investment return kick on any employer-sponsored retirement savings plan comes from the match. At the stage of life when you are savings for retirement you want to build up tax sheltered savings in a well-diversified portfolio. And you can put up to $10,500 in a SIMPLE this year ($13,000 if you’re over 50).

We’ve all gotten a lesson in how diversification doesn’t shelter a portfolio much during a global economic meltdown—unless the portfolio is heavily invested in Treasury bills, Treasury Inflation Protected Securities, or a similar safe haven. But that doesn’t mean diversification, compounding over time and dollar cost averaging (putting money into the market on a regular basis) isn’t a good strategy. The advantages of diversification will reemerge, typically within is three to six months, estimates Ross Levin, a certified financial planner and head of Accredited Investors Inc. in Edina, MN. “During times like this, don’t extrapolate what is happening today to fifteen years down the road,” he adds.

The current stock market “bargain” could become more of a bargain down the road. I’m not a market timer. Still, I like stocks. I am confident that the U.S. economy will rebound and that owning the total stock market index will pay off over time. So, I would continue to fund a retirement savings plan, and I would stick to a well-diversified portfolio. Time remains your friend.

However, assuming you continue to put savings into a retirement savings, then by all means take some of your discretionary income and it to work toward paying down your student loans.

10/07/08 by Chris Farrell

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Rebalance portfolio?

Question: I’ve generally tried to rebalance my portfolio at the end of each quarter. However, with the stock market volatile and descending, I’m reluctant to rebalance toward stocks until I see some stability in the market. What’s your recommendation regarding asset allocation and portfolio rebalancing in these troubled times? Mike, Woodbury MN

Answer: Whew, it’s hard to sell a good performing asset and buy a poorly performing one under normal circumstances, let alone during a bear market. From your email, it sounds as if you’re pleased with how you’ve allocated your money between various investments, such as stocks, bonds, and international equities. It’s the timing of getting back to the percentages you choose that’s troubling you. “Rebalancing is critical during these periods,” wrote Ross Levin, a certified financial planner and head of Accredited Investors Inc. in Edina, Mn. in a recent letter to clients. “By systematically rebalancing, you are forcing yourself to buy low. It has worked for us time and time again in my twenty-six years in this business.”

The list of unthinkables that has happened recently is long and growing. But I still think that Ross Levin is right. Rebalancing will pay off. And there’s no question that doing nothing will impact your asset allocation. For example, suppose you divided your portfolio into 60% stocks and 40% bonds. But after that you didn’t touch it. According to recent calculations by money managers Mark Kritzman, Simon Myrgren and Sebastien Page stocks would have varied from a low of 33% to a high of 99% during the past eight decades. Moreover, they add, the portfolio would have been more than 10% over-weighted in stocks nearly 75% of the time.

You can rebalance your portfolio either by redirecting future purchases or by shifting money among current holdings.

10/08/08 by Chris Farrell

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A money market mutual fund clarification

A clarification: There has been some confusion about an answer I gave last week about money market mutual funds. The Treasury stabilization fund only backs money that was in a money market mutual fund as of September 19. Plus, the money market fund has to decide to participate in the Treasury program. If you transfer money from a money market mutual fund that isn't participating in the program into one that is you won't get the Treasury backing since the funds had to be deposited before September 19.

However, I do think that the odds of a run on a money market mutual fund that is part of the program dramatically shrinks. There is an extra layer of safety even for money deposited after September 19.

10/09/08 by Chris Farrell

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Time to buy a condo?

Question: Thanks for being a voice of reason, especially these past few weeks.

I am a 56 yr old, single woman. I owned my own business for 16 years and consequently am only now beginning to put away money for my retirement. I have about $35,000 inheritance from my father. I am employed at a non-profit research institute, which relies largely on grant funding, but which has been decently funded for 50 yrs.

Here's my question: as I am looking to plan a retirement, I am considering buying a condo now in the $200 - 235,000 price range (housing here is such that anything less than that is nothing I'd really want to live in). If I use the inheritance money for a downpayment, I should be able to get a mortgage that I can comfortably afford - and still be able to put money in my 403B(10% of my salary + 3% from company and HSA ($3800. per annum). So, is this a brilliant time for ME to buy? Or is it foolish?

I keep my money in a local FCU, and although I haven't looked recently, I believe they are still making mortgage loans. I look forward to your thoughts. Mary Ellen, St. Paul MN

Answer: It's intriguing that we're starting to get more questions like yours. Home prices may be hitting a level that interest more buyers.

I think now is a great time to look for a house, to research a home, to visit lots of homes and condos, investigate neighborhoods, and really figure out what you like in your price range. I don't think you are being foolish at all.

That said, there's no rush to buy. It's a safe bet that home prices are still heading lower, especially with the economic downturn gathering momentum. I believe the credit crunch or credit crisis will come to an end. Clearly, it won't be easy, but governments and central bankers everywhere are making a concerted effort to break the credit logjam. Yet the damage to the real economy of goods and services, jobs and incomes will haunt us for a long time even after the financial institutions start borrowing and lending again.

Of course, none of us can really time bottom. But if you spend the time now finding what you want you can then evaluate whether it's a good buy for you. And at some point prices will bottom out and the market rebound.

When you're looking, also think about retirement. For when it comes to finding a retirement home, the best answer for many people is current home. I have a feeling that you'll want to stay in this place, so look into how feasible the condo is from a long term care point of view. Staying at home doesn't just mean judging whether its an easy place to live in as you age, but it also means evaluating the infrastructure of your neighborhood. Among the key question to ask: Is there convenient public transportation or are family and friends willing to drive you around? What medical and home health care services are available?

by Chris Farrell

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Buy gold for IRA?

Question: Hi Chris, I am seeking advice as to what I should do with my IRA fund. I have a portfolio of various mutual funds that used to be worth $ 17,000 now is about $ 13,000. I have lost plenty from the latest stock market crashes. Since it might be a long while till the bull market reappears, do you think I should keep things as they are or should I cash out or are there other options?

I realize I will take quite a hit if I cash out so what other alternatives do I have that could spare further losses in the market. I have been thinking of buying gold certificates with some of the money I have in my IRA, would this be a wise move? Theresa, Manchester

Answer: Last night at NET in Nebraska I participated in a statewide public radio and public television call-in show. In essence, the topic was the global financial crisis and you. The questions were terrific and it was a good show. You can listen to it at NET Nebraska.

Gold came up several times during the conversation in Nebraska. It's a traditional safe haven, and the price of gold has jumped to over $900 an ounce in the commodity futures market. Is gold a place to seek shelter from the financial storm?

I'm a skeptic. The precious metal has been doing well during the financial crisis. It could do a lot better, too. My problem with buying gold now is that it's a pure speculation on price appreciation--a bet that you will be able to sell it at some point in the future at a higher price than you bought it. But the metal is volatile. Again, it's a speculation. Put it this way: Gold doesn't pay dividends. It doesn't create cash flow. It fluctuates on speculation. It isn't a good investment for an IRA.

If you want to own gold I would do so outside the IRA. The are some exchange traded funds (ETFs) that offer a cost-effective option for the individual investor. There are also some mutual fund options.

The counterpoint to my perspective on gold comes from mutual fund maestro Jean-Marie Eveillard. He had a terrific long-term record running the First Eagle Global Fund for more than a quarter century. Like many wealthy Europeans, he always had a small percentage of the mutual fund equity portfolio invested in gold. He treated it as an insurance policy. When the equity markets went down, the price of gold would go up, cushioning the impact on the portfolios value.

Still, I prefer Treasury bills and Treasury Inflation Protected Securities. These are investments that preserve capital and make you some money. No one will get rich with these securities, but the value of a dollar will be preserved. TIPS are a more cost effective insurance policy.

10/10/08 by Chris Farrell

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The FDIC, a bank merger, and deposits

Question: Hey - Imagine that last week I had $250,000 in deposits in Wachovia and another $250,000 in Wells Fargo, all FDIC insured, all okay. Now that they are the same company, would I still be fully insured? Bill, Louisville KY

Answer: I don't think I'd go to Las Vegas with you, but as far as your insured deposits go you would be just fine. According to the Federal Deposit Insurance Corp. when two banks merge--whether it's a shotgun marriage or a voluntary union--the FDIC provides a "grace period" that protects depositors with funds at the two banks. As a general rule, the accounts would continue to be separately insured for 6 months after the merger. The idea is that 6 months gives you enough time to make any needed adjustments to your accounts to stay insured going forward.

By the way, the grace period can be longer for certificates of deposit (CD). When a CD is taken over by another bank thanks to a merger, it continues to be separately insured until the earliest maturity date after the end of the six-month period.

10/13/08 by Chris Farrell

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Gold, again

Question: If very high inflation is in our future due to the Great Bailout, would your same advice re gold in a IRA still hold? Ned, Melbourne FL

Answer: Gold will do well if the massive government bailout does lead to a high and rising increase in the overall price level or inflation rate. Gold is a traditional hedge against the debasing of the currency, and gold did spectacularly well during the Great Inflation of the 1970s. The price of gold soared in recent years along with skyrocketing prices for food and energy.

When investors get truly nervous about the U.S. economy many seek refuge in gold. Considering how scared so many people are today even after the Treasury announced the semi-nationalization of 9 major U.S. banks it's no surprise that gold is trading at $842 an ounce. That's down from a peak of more than $900 an ounce, but still high.

By the way, gold's previous peak was $850 in 1980. Adjusted for inflation, gold would have to reach over $2224 an ounce to best that price.

That said, I don't think we're going to have another Great Depression because the actions being taken by the monetary and fiscal authorities will succeed at restoring trust in the credit markets. I do believe the recession in the U.S. will be long and severe. I am more worried about the prospect of deflation or a decline in the overall price level than I am over inflation. Asset prices are sharply lower. The banking system is damaged. The competition for markets and profits will heat up in the global economy with growth slowing worldwide. Taken altogether, it seems like a recipe for falling prices. Even the International Monetary Fund has also weighed in on the topic, arguing that deflation is a real risk in a decelerating global economy.

But you could be right. Forecasting is a hazardous business. I still consider putting money into commodities a speculation and not an investment, especially in a retirement savings account. It's a gamble that you'll be able to sell the metal at a higher price in the future.

The traditional European idea of keeping a small percentage of an overall portfolio in gold as a hedge against political and economic crisis doesn't bother me. But I still prefer investing my "insurance money" in Treasury Inflation Protected Securities or TIPS. It's a default free security. You'll earn a rate of interest. You'll preserve the value of your capital with the inflation adjustment (based on changes in the CPI.) TIPS are also designed to act as a hedge against deflation, too. (While some commentators believe the Consumer Price Index is manipulated by the government I've never found the argument particularly convincing.)

The bottom line: I'm not a speculator with my retirement money. I prefer investing in my IRA. If you want to bet on the future price of gold I'd recommend doing it outside a retirement account.

10/14/08 by Chris Farrell

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Tax exempt bonds

Question: Can you explain why an ETF that invests in 100% government insured revenue and general obligation municipal bonds would be sliding so precipitously on good days and bad ones? Thank you. Marysa. Delray Beach, FL

Answer: The tax exempt market still has a stodgy image of a market that barely moves with wealthy investors complacently clipping their coupons. The market hasn't been that way for a long time and lately it has been on a wild ride. The slide in value in your exchange traded fund or ETF reflects investor nervousness over credit quality, state and local government finances and the recession.

First, a brief definition: Tax exempt or municipal bonds are sold by state and local governments to fund roads, sewers, schools, stadiums and the like. General obligation bonds (GOs) are backed by the full taxing power of the state. It's the safest sector of the tax exempt market. Revenue bonds are typically backed by a stream of income, say, from a toll road. The income backing a revenue bond can be fairly assured or very risky.

In recent decades, state and local governments boosted the rating--and lowered the yield--mostly of their revenue bonds by buying private insurance that protected investors in case of default. It was a great business for the private insurance companies since default rates in the muni market have been traditionally low in recent decades. (I always thought the business was a scam but that's a story for another day.) In recent years, the insurance companies decided to make even more money by getting into riskier businesses where they could charge higher fees--including exposing their balance sheets to subprime loans. The move backfired badly with the housing market implosion and the credit crunch. The insurance company debacle has roiled the market.

What's more, state and local government revenues are crimped by the downturn in the economy. The consensus is that the tax revenue situation will only get worse since we are either in a recession that is spiraling downward fast (as I think) or the country is about to enter a recession that could get severe (the opinion of many economists). The expectation is that the tax exempt market default rates will be higher than recent experience, too. The last time the there were a lot of state and local government defaults was during the Great Depression.

Taken altogether, the uncertainty has driven bond prices down and bond yields up. The nervousness in the market is so great that muni bond yields are now higher than comparable U.S. Treasuries. That's amazing considering that muni bond yields are exempt from federal taxes. (Many muni bonds sold within a state are also exempt from state and local taxes. But since many muni bond mutual funds and ETFs buy bonds issued across the country you'll pay state income taxes on that kind of investment.)

Let's assume you're in the 35% federal income tax bracket. You also pay a 10% state and local tax rate (the national average). Today, the 3-year Treasury note yields about 3%. The highest quality muni bond with a comparable maturity yields some 3.6%. The muni bond yield is the equivalent of a 5.5% taxable yield. If you're in the 28% tax bracket the muni bond is still paying the equivalent of a 5.1% taxable yield.

Munis are offering their investors attractive yields, but the higher yield reflects greater risk.

10/15/08 by Chris Farrell

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Where are the stock market "circuit breakers"?

Question: why did the market not shut down during the freefalls in the past weeks?

i remember that it would shut down as did russia's in a free fall before this administration. Kate. Los Angeles, CA

Answer: I wondered the same thing. It turns out the market didn't fall enough.

The New York Stock Exchange established "circuit breakers" following the market crash of October 1987 and the plunge in the stock market in October 1989. (What is it about October and plunging stock prices?) The triggers for the circuit breakers are set at 10%, 20% and 30% of the Dow Jones Industrial average from a level calculated at the beginning of a quarter. Here are the figures for the fourth quarter of 2008.

According to the New York Stock Exchange, in the event of a 3350-point plunge in the Dow (30%) the market would close.

If the Dow dropped by 2200 points (20%), there would be a two hour stop in trading if it happened before 1 PM. (Between 1 and 2 the market would close for an hour and after 2 trading would halt.).

If the Dow falls by 1100 points (10%) before 2 PM trading would stop for an hour. (Between 2 and 2:30 there would be a half-hour stop and after 2:30 the market would stay open.)

Let's hope we don't see the kind of one-day drop in the Dow that would trigger the circuit breakers.

10/16/08 by Chris Farrell

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Moving soon and savings

Question; My husband and I are both in our early 30s and now that we are both finished with graduate school we are finally in a position for the first time in our lives to have money to invest. The money that we had saved prior to grad school had gone to purchasing our condo. We are both putting some money away for retirement through our jobs and we don't have any debt except for our mortgage and what is left on our student loans. I was planning on contacting a finical adviser however now that so many investments are loosing money (including the ones that our retirement funds are in) I am considering putting our money in some short term CDs and investing it in 6 months or so. Is this a bad idea? We were hoping to use at least some of the money to by a house in a little over a year when my husband finishes his post doc and we have to move. I have read through some of your other advise and have seen that you mention money market mutual funds often. Would this still be a good idea right now? Elizabeth, Bozeman MT

Answer: My advice for you would be the same in good times (remember those days?) and bad times (like now): Stash your short-term savings in a very safe place. The price for safety will be a low yield, but that's okay. The savings will be there when you need it.

After all, the savings will be tapped in a relatively short period of time, perhaps a year or so from now. You'll be moving and that's always expensive. You may buy a house and you'll probably want to sell you current condo. A certificate of deposit (CD) at a federally insured bank or credit union is a safe parking place for savings. If you do decide to go the money market mutual fund route, remember my two maxims for safety. First, go with a blue chip, nationally and internationally known financial institution and, second, stick with the U.S. Treasury security-only option (or the money fund that is primarily comprised of short-term Treasury securities.)

What's more, I'd put the money in a money market mutual fund that has decided to participate in the U.S. Treasury's new stabilization program. The money market fund has to sign up. To be sure, the government fund only backstops money invested in a participating money market fund before September 19th. Still, it does offer reassurance to those investors and is a source of stability to the overall fund.

For your longer term investments, including retirement, I would build up a well-diversified portfolio. I agree with an Op-Ed piece Burton Malkiel wrote in yesterday's Wall Street Journal. He's a finance professor at Princeton University and author of one of the best selling investment guides of all time, "A Random Walk Down Wall Street:"

But just because stock markets have panicked, investors should not. The best position for investors today is not "fetal and 100% in cash." We are not going to have a depression, and we have survived financial crises before. A century of investing experience, as well as insights from the field of behavioral finance, suggest that investors who bail out of equities during times like these are almost always making the wrong decision.

It is very tempting to try to time the market. We all have 20/20 hindsight. It is clear that selling stocks a year ago would have been an excellent strategy. But neither individuals nor investment professionals can consistently time the market. The herd instinct is extraordinarily powerful. When the economy and the stock market were booming in early 2000, investors could easily convince themselves that prosperity would continue without interruption and that stocks catering to the "New Economy" were surefire tickets to wealth..... The herd instinct works exactly the same way in bear markets. Nervous investors convince themselves that every "light at the end of the tunnel" is a train coming in the opposite direction. Panic is just as infectious as blind optimism.

Before you hire a financial advisor, I'd get a copy of Burton Malkiel's "The Random Walk Guide To Investing: Ten Rules for Financial Success". It's in paperback (so it's a lot cheaper than hiring a financial advisor) and the short book contains the kind of information most of us need to do well investing over a lifetime.

10/17/08 by Chris Farrell

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Online Savings and CDs

Question: I hear a lot about money market accounts, and Roth IRA's as safe haven's for investing. I've been putting money away in a ING savings account (was earning 4% at one time, now 2.75%). How come I have not been hearing of this as a viable option as a secure place to keep money? Is there an advantage of a money market account vs the ING account? Scott, Tallahassee, FL

Answer: Online bank savings accounts backed by the FDIC are a great place to save. You're not only earning a higher rate than you do on the safest money market mutual funds, but the savings are insured by the FDIC. We've been listing this kind of savings account on our menu of safe options for savings we've discussed during the credit crunch and financial crisis.

Speaking of the financial crisis, it continues to reverberate throughout Europe. Most recently, the government of the Netherlands is putting more than $13 billion into ING Groep NV, the banking and insurance giant. The financial behemoth says its oldest legal predecessor is the Kooger Doodenbos from Koog, Noord Holland, founded in 1743. ING is now one of the world's largest deposit-gathering financial institutions. It remains high on anyone's list of strong financial institutions, but investors are so nervous that the bank and the Netherlands' government decided to make a prudent injection of money before confidence started eroding. The ING parent company owns ING Direct, the online bank that operates in the U.S. and elsewhere. The key for you and others is that deposits in the U.S. branch of ING Direct are backed by the FDIC--assuming the sums saved come under the $250,000 insurance limits.

Investors are pouring more money into certificates of deposit, too. Still, considering the flight to safety and the current nervous environment, rates aren't bad. The national average for a 1 year CD is 3.6%, according to bankrate.com. (The website is a good source of information on CDs, savings rates, mortgages, etc.) Still, you can do better than that. For instance, my online bank is offering a two-year CD at 4.15%. That's well above the 1.7% yield on a two-year Treasury note. yet the risk of owning the CD is the same as owning a T-bill if the account is backstopped by the FDIC. .

10/20/08 by Chris Farrell

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Fannie and Freddie?

Question: Many of us know about the woes being felt by Fannie Mae and Freddie Mac, and their stock performance tells it well. But is now the time to buy them? I mean, with a history of a 40-60 point value, a low current value, and (seemingly) a government assurance of not failing, it seems pretty attractive to this novice investor. Thanks! Mark, Charlotte, NC

Answer: You're right that the stock of Fannie Mae and Freddie Mac are still trading. But "low" seems too mild a word. As I'm writing this, Fannie Mae is trading at.880 a share--down 97.7% year-to-date. The comparable market figures for Freddie Mac are .940 and -97.1%, respectively. That's a disaster for shareholders.

Here's what the market service Morningstar said about Fannie Mae last month:

"The magnitude and duration of the housing bust and job losses will largely determine Fannie Mae's fate. If the spiral of downward home prices, negative equity, foreclosures, and lack of financing alternatives continues, Fannie Mae might need substantial additional equity capital in order to operate. Not only are higher minimum capital standards and additional dilution a risk, the firm appears to be losing control over pricing, growth, and underwriting decisions to its conservator. The firm could also be nationalized outright based on future political decisions."

The same holds for Freddie Mac.

I'm not a stock picker. I don't think novice investors should be speculating. I guess if you have some entertainment money that might go toward an evening out, the slots at Las Vegas, or the stock of Freddie Mac and Fannie Mae, then by all means take a flyer. But its not an investment. It's a speculation.

10/21/08 by Chris Farrell

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Microfinance and the financial crisis?

Question: With all this talk of the credit crisis, I'm wondering what's become of microlending and those microlending companies you've covered in the past. Maybe you could do a follow-up on some of them? Thanks, Spencer, Andover, MA

Answer: My suspicion is that microfinance will do well--and maybe even expand--during the financial crisis. Certainly that's the point of view of Muhammad Yunus, the founding father of microfinance. The modern microfinance business began when Yunus established the Grameen Bank in 1983. It offered very small loans to impoverished people, mostly women, to finance small business ventures. The Grameen Bank, which won the Nobel Peace Prize jointly with Yunus in 2006, now has a far more solid loan portfolio than many global commercial banks. In a recent interview with Business Week. Yunus said, "Our system is based on trust, not collateral or guarantees, and still the people pay back."

Swaminathan S. Anklesaria Aiyar agrees. A leading Indian journalist and consulting editor to the Economic Times recently wrote: "This is extraordinary. Big financiers lend against collateral, a back-up if their borrower defaults. But MFIs [microfinance institutions] lend with no collateral at all. Big financiers lend to the most creditworthy corporations. MFIs lend to poor women whom nobody in history considered creditworthy before. Yet, the secured loans to big corporations are bombing, while unsecured loans to poor women are being repaid in full."

The track record is good. The need is there. The microfinance world is one where very small sums can make a big difference. And for many people the lure remains: Even though most microfinance institutions are started with public or philanthropic money, or money from other sources, many eventually become self-sustaining, profit-making enterprises.

It's a story well worth following. Thanks.

10/22/08 by Chris Farrell

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A margin of safety

Comment: My husband and I are respectively 81 and 76. Luckily my husband is very conservative and has invested largely in CD's, bonds and TIPS. About 6 % of our networth is in stocks. We live frugally, having sold our house in Connecticut in 2005, and leased a rental apartment in Milwaukee. So we are not likely to be greatly affected by the downturn. Regina, Fox Point, WI

Answer: I know there is no question here. But I've posted Regina's comment because it shows the payoff from managing finances conservatively. Their situation echoes remarks by Jack Bogle, the octogenarian founder of the mutual fund giant Vanguard, in a recent conversation I had with him: "I am a believer in diversification. You buy index funds for stocks, and your bond portion should equal your age. This is how I invest, so I know how little it's hurt me to have a substantial position in U.S. bonds."

Whether young or old, everyone needs to build in a margin of safety. After all, you can't get rid of the uncertainty. As Don Quixote de la Mancha said: "Tis the part of a wise man to keep himself today for tomorrow, and not venture all his eggs in one basket."

10/23/08 by Chris Farrell

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TIPS

Question: On a recent show, you suggested that investors should hold a significant amount of TIPS in their IRAs. I think this is a reasonable idea so I started looking into doing this. I believe that the best way to purchase and own TIPS is to own the bonds directly, since then you are locking in the maturity date. The best way I found to buy TIPS in this way is through TreasuryDirect. However, I could find no way to be able to purchase through TreasuryDirect from an IRA. So my question is: Is there a way to buy TIPS from an IRA using TreasuryDirect? Robert, Shoreview, MN.

The alternatives are

1)Buying TIPS on the secondary market from a brokerage account in an IRA. This is inferior for three reasons : you pay a commission, you will get hit with a heavy spread, it is difficult to calculate the actual "base" interest rate you will be getting.

2) Buying a TIPS mutual fund in your IRA. This is inferior because TIPS funds actually act much like bond funds, and fluctuate based on current interest rates. Also, there's the added complexity that they also will fluctuate based on inflation expectations. And there is no fixed maturity.

Answer: You're absolutely right, and it's a disgrace. I know a number of finance academics like Zvi Bodie of Boston University have lobbied for the Treasury to let individuals buy from Treasury Direct in their IRAs. But it looks like Treasury is more concerned about Wall Street commissions than the retirement security of the individual saver. The same goes for their decision to limit the amount of tax sheltered I-bonds that an individual could buy in any one year. (The limit is $5,000 electronically and $5,000 in paper bonds.)

I still like TIPS. I prefer buying on the secondary market because then you know what you have and when it will mature. But a lot of people are uncomfortable with that. In that case, I would go the mutual fund route.

10/24/08 by Chris Farrell

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Nationalizing 401k assets?

Question: Will you be writing of alternatives to 401ks in light of articles intimating the House is interested in the idea of nationalizing 401k assets? Bill, Golden Valley, MN

Answer: I've seen the phrase "nationalizing" retirement money in a number of different contexts. Still, this rumor seems to be getting some play for a number of reasons. For one thing, the list of "unthinkables" that have actually happened is long and growing. A conservative, Republican Administration engineering a more than $1 trillion bailout -so far--of the financial system. The government seizing control of mortgage giants Fannie Mae and Freddie Mac, and the global insurance giant AIG. The failures of investment banks Bear Stearns and Lehman Brothers. The quasi-nationalization of the banking system. The American taxpayer backstopping the $3.5 trillion money market mutual fund business. The possibility of another Great Depression.

For another, Argentina's government is out to nationalize some $30 billion in private pension funds. The stated reason is to protect retirees from falling stock and bond prices. But the real reason, it appears, is a desperate move by the government to shore up its deteriorating finances.

Last, charges are flying that Sen. Barak Obama will pursue a socialist agenda if he wins the race for the White House, as appears likely.

While all of us have to be careful when we say something will never happen, 401(k) assets and the like won't be seized by the government. No way. No how. Period.

To be sure, if the financial crisis continues the government may takeover or invest in more financial institutions that manage retirement assets--from insurance companies to banks-- but the U.S. government isn't the same as the Argentinean government. Congress and the White House aren't going to seize our retirement money. Barak Obama isn't a socialist and he has no socialist agenda.

That said, there are good reasons for wondering whether Wall Street should manage any of our long-term retirement savings funds. Put somewhat differently: Is the 401(k) plan, which has become the main retirement savings vehicle for the American worker over the past three decades, a mistake?

I think the case for rethinking the 401(k) as a pillar of retirement savings is compelling.

To be clear, the democratization of stock ownership is a welcome and powerful trend. Two hundred years after 24 New York brokers and merchants met on Wall Street to sign the "Buttonwood Agreement," a pact that established standard commissions for trading securities, investing now has all the characteristics of a mass social movement. People's Capitalism has helped fuel entrepreneurship and risk-taking. Despite abuses, stocks options, restricted stock, profit sharing plans, and similar equity-based compensation schemes are critical building blocks to innovation, the driving force behind economic growth. Thanks to the Internet and advanced telecommunications networks, it's cheaper than ever for individual investors to buy securities.

No, the question is focused on retirement savings, the money employees set aside during their working years to smooth out their standard of living in retirement. Employees bear all the responsibility if the worker make mistakes, and time to make up for investment mishaps shrinks as stomachs go slack and hair turns gray. It's an axiom of modern finance that the only way to create the possibility of higher returns is to take on greater risk. But the risks employees are absorbing today seem disproportionate to the potential rewards.

What's more, our retirement savings system is far too balkanized. There's 401(k)s for the private sector; 403(b)s for non-profits; 457s for state and local government employees; and SEP-IRAs for the self-employed. Then there are IRAs and Roth-IRAs. All have different rules, income limits, and restrictions. For example, you can put a maximum of $15,500 into a 401(k) while the contribution limit to an IRA is $5,000. The maximum into a SIMPLE IRA is $10,500. It makes no sense.

There is plenty of room for improvement. There have been hearings on Capital Hill recently, looking into retirement security. There should be more.

Pension experts are working on ideas that may make it easier for workers to save for the last stage of their lives. For example, a number of academic quant jocks are exploring creating annuity-like products that would guarantee workers a steady, inflation-protected income during their golden years but would be less expensive for companies to offer their employees than the traditional defined-benefit pension fund. The demand then would be on workers to take the responsibility of saving but they would avoid the burden of investing.

These ideas are worth exploring.

But as for seizing pension assets? Not a chance.

10/27/08 by Chris Farrell

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Borrow to buy?

Question: The stock market meltdown that we're facing today looks like one of the best stock buying opportunities that I am likely to face in my lifetime. I don't have a lot of spare cash, so I'm considering borrowing some money to buy some mutual funds. I'm 34, have a stable job in a good company. I have a 30-year fixed mortgage and a HELOC that currently offers an interest rate of 5.25%. I don't have much debt other than a car loan that I'm paying down. I am going to school part time on a student loan. I'm thinking about taking $4,000 or $5,000 out of the HELOC and buying an index fund or a financial sector fund. What do you think? Patrick, Atlanta GA

Answer: Big mistake. Yes, stocks may offer a high potential return, but only by taking on a considerable amount of risk. Remember, stock market returns are not guaranteed, but you will have to meet the interest payments on your loan no matter what--or put your house at risk. Borrowing on your home to invest in the stock market is always a bad bet. And in the current environment people need to be paying down debt, not adding to it.

That said, you could be right about the stock market. I don't know when or where the stock market will hit bottom, but there is value in the market. And there was a spectacular raly today of some 11%.

Warren Buffet, the famous stock picker, is buying. So is Marty Whitman, another well-known value investor of Third Avenue Management. Jeremy Grantham, the legendary investor at Boston-based GMO told Business Week that stocks are now cheaper than they've been since 1987. "You are looking at the best prices in 20 years, and you should be making 7% to 8% to 9% real [inflation-adjusted] returns," he said. "The last time I was this optimistic was in the summer of 1982."

These three long-time investors have built sterling money making reputations over a long period of time. Here's what Jack Bogle, the octogenarian founder of the mutual fund giant Vanguard, told me in a recent interview: "We can, however, look ahead and make reasonable predictions. In the bond market, we know with 90% probability that return in the next 10 years will be 4.5% to 5%. That's the historical number. If we have huge inflation and a Great Depression, and lots of bonds default--this is why I like Treasuries--then that's something else again. In stocks, we know the sources of stock returns. Dividend yield is almost 2.5%, and earnings growth from these levels ought to be 6% over the next decade. That's an 8.5% return."

Grantham notes that when bubbles burst markets historically overcorrect by a lot. Your idea is a reasonable bet. But don't borrow the money. Use cash.

10/28/08 by Chris Farrell

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Harvesting capital losses

Question: My portfolio contains some stocks that have cratered -- and I don't expect them to turn around soon in this economy. Might it be beneficial to take a long-term loss on them this year, with an eye toward lowering current taxes and trimming some dead wood? Thanks, Dave, Reston, VA.

Answer: The answer is "yes" to both questions. You will have a lot of company taking capital losses this year, especially with the stock market down about 35% year-to-date. It's also a good time to harvest some dead wood. However, when evaluating investments remember that the underlying fundamentals trump tax strategies.

That said, the capital gain section of the tax code is a fertile area for tax-savvy financial planning. You need to sell in order to get the capital loss or losses, defined as selling an investment at less than the price you bought it for or its adjusted basis. (The expenses you incur selling the investment are deducted from the proceeds and added to the loss.) And, of course, we're looking at stocks, bonds, or other investment in a taxable account. For instance, you can't deduct losses in a tax-deferred retirement savings account, such as a 401(k).

Of course, since we're dealing with taxes the calculation isn't simple. You'll want to familiarize yourself with Schedule D, as well as the differences between short-term and long-term losses and gains. Computer-based programs like Turbotax are helpful or you can hire an accountant to do it for you. If you have a capital loss remaining after offsetting any capital gains you've realized, you can still deduct $3,000 from your income taxes. If the loss is greater than $3,000 you can carry the leftover portion to the following year, and the year after that, and so on.

10/29/08 by Chris Farrell

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Where is the money going?

Question: If everyone is withdrawing money from stocks, mutual funds, hedge funds and every place where they have money, what are they putting it into? I can't believe that all the money that has been withdrawn is just lying idlely around. Nobody does that. It has to be invested in something. Jerome, Boiling Springs, PA

Answer: You're right that money is fleeing out of risky assets like U.S. stocks, emerging market equities, and junk bonds. To give you just one example, investors have pulled some $124 billion out of stock mutual funds year-to date (the data goes through September), according to the Investment Company Institute, the Washington D.C. based trade group for the mutual fund industry. Of course, there are still lots of buyers in the stock market looking for bargains.

Still, many savers are looking for a "safe harbor" for their money. The most popular safe harbors rely on U.S. government backing rather than private sector promises.

Therefore, investment money at home and abroad is pouring into default-free U.S. Treasury securities. Investors are so eager to preserve the value of their money that they're willing to accept a mere 0.44% yield on a 3-month Treasury bill and only a 3.9% yield on a 10 year Treasury bond. Savers are also seeking safety in banks backed by the FDIC and the comparable federal backstop for credit unions. Savers are putting their money into certificates of deposits, savings accounts, and the like. The money is safe at the federally insured bank or credit union so long as it's under the $250,000 FDIC limit. (There are a number of ways to increase coverage limits even at the same bank. The FDIC has a clear explanation of its insurance fund at www.fdic.gov. )

One reason the Fed cut its benchmark interest rate to 1% is to encourage both savers and lenders to take on a bit more risk. For savers, the lure of high returns in a low interest rate environment could entice them to snap up quality corporate bonds, good tax exempt bonds and blue chip stocks. For lenders, it boosts confidence that the financial world is not coming to an end and that could lead them to make more loan money available to the average worker.

10/30/08 by Chris Farrell

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The end of indexing?

Question: Chris, My wife and I have been following your advice (and the advice of many others) for retirement investing for years. We have about 15 years until we hope to retire (of course, hope is the operative word there, since the gallows humor going around these days is that "80 is the new 65"). Basically, we buy broadly diversified index funds on a monthly, dollar-cost averaged basis, and we hold (about 65% equities and 35% bonds). I'm watching the beginning of yet another bloodbath day for the stock market this morning (October 24) and I've recently started to question this buy and hold strategy. It really hasn't work for the S & P over the last decade or so. With pundits throwing around opinions like "there won't be another secular bull market for a long time, but there will be cyclical bull markets in the coming years," isn't an active buy and sell approach a better one, and, if so, how does the average investor participate in that approach? Richard, Bozeman, MT

Answer: Another gallows joke I've heard is that a "walker" is the new corporate benefit.

On to your question: One personal finance lesson not to take away from recent experience is that indexing is a mistake. Yes, I imagine you're hearing talk about how professional money managers can avoid the investment carnage by trading adroitly. That's reminiscent, at least to me, of comedian Will Rogers famous quip, "Buy stocks that are going up. After they have done that, sell them. If they ain't going to go up, don't have bought them." Or, as Rex Sinquefield, chairman and chief investment officer at Dimensional Fund Advisors, once said: "There are three classes of people who do not believe that markets work: the Cubans, the North Koreans, and active managers."

There's no reason to believe that actively managed mutual funds will systematically do better after fees in this market--or any other market for that matter. (And a lot of hedge funds--managed by the best and brightest--are getting wiped out these days. It's one reason the stock market is so volatile.) In a sense, Wall Street takes its cut everytime an actively traded mutual fund or managed account makes a bet, and their take slices into returns. "Meanwhile, Wall Street's Pied Pipers of Performance will have encouraged the futile hopes of the family. ... will be assured that they all can achieve above-average investment performance - but only by paying ever-higher fees. Call this promise the adult version of Lake Woebegon."

Who wrote that? Ralph Nader? No, it was Warren Buffett, the greatest stock picker in modern times. He's spot on.

The expense ratios on index funds are razor thin--ranging between, say, 0.10% and 0.20% for a broad-based equity index fund vs. 1.0% to 1.5% for a comparable actively managed funds. Over the years, that fee advantage adds up. Then there is the cost of time. You have to ferret out good mutual fund money managers, or pick out stocks on your own, and then monitor them closely. That's tough to do. In a letter to shareholders Buffett made a strong case for the kind of value oriented stock picking approach that he practices--which is knowledgeably poring over balance sheets and studying management. But if truly understanding a company isn't your passion, then use index funds, he advised. "By periodically investing in an index fund, for example, the know-nothing investor can actually out-perform most investment professionals," Buffett wrote. "Paradoxically, when 'dumb' money acknowledges its limitations, it ceases to be dumb."

10/31/08 by Chris Farrell

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