Saturday, October 4, 2008

Savings Accounts, Part Trois: Staying Safe in an Unsafe Financial World

We all know that the finance side of the American economy is in meltdown right now, so let’s not talk about that any more until it reaches some stability. Let’s talk about our personal savings, which we don’t want to see vanish through either a stock market that stays down forever or inflation that wipes out the value of those savings.

An entire generation of Americans has been persuaded to put its personal retirement savings, usually as 401 (k)s or IRAs, into the stock market. Which did not feel very good in 2001 when the stock market took a serious tumble after the tech meltdown. And it doesn’t feel very good today, either, with major investment companies failing and banks going under, too. But down markets don’t usually last. Given time, our stocks will recover. Or at least, they should. The one aspect that bothers me is that for the first time ever, foreign investors, the very people whose fickle confidence has been responsible for major financial collapses in many developing nations, are not confident in America. These foreign investors are waiting for the fire sale; they aren’t treating this dramatic mess as just a minor blip. I believe this is a genuine and scary sign that the US is on its way out as a major economic power. The power issue doesn’t bother me as much as the fact that we could become helpless pawns in the same games of economic opportunism that messed up many another country’s economy and plunged it into runaway inflation. And inflation will destroy the value of our savings and of our 401(k) and IRA accounts.

Maybe. As I’ve said before, if the mortgage stays the same and the dollar amount we have in savings stays the same, then we haven’t lost anything as long as we pay the mortgage with those dollars. The same thing with paying any other fixed obligation incurred before inflation. The principal doesn’t rise, so dollars that are worth less will still pay off the same dollars of debt. The problem is going to be when we try to live on assets from a 401(k) or a pension (we should be so lucky to have one) that add up to a fixed dollar amount when the price of everything has gone up via inflation. Then, we’ve got trouble. Some retirement payouts are indexed to inflation; others are not. And therein lies the potential to be faced with eating cat food in our old age or not buying needed medicines, because our income dollar amounts have not increased to match inflation.

Which leads us back to the stock market and all the risks it entails, because it is about the only game in town that can offer profits that hedge against inflation. Yes, there are TIPS, the US Treasury Inflation-Protected Securities. But buying TIPS is complicated and yearly recordkeeping regarding their earnings is required. Unless you are a financial expert, you’re pretty much stuck using a broker to buy TIPS, and that means more fees as well as exposing yourself to the persuasion of a broker to do something not in your long-term financial best interests. And as far as I know, TIPS cannot be part of a retirement account. (If you know something different, please comment.) Thus anyone contributing to income tax deferred 401(k) or IRAs is not able to sock that money into TIPS. Another reason why our contributions to retirement are mostly at risk.

There’s also the bond market, and most of our 401(k) portfolios do include some bonds. But unless we buy bonds at a discount on the face value, they don’t pay much. And their value never goes up. They do not protect us against inflation. Although bonds are the first call on a bankrupt company, ahead of preferred stock, they’re still a risk. In the current meltdown, even bondholders could take some unpleasant payoffs if the money just isn’t there anymore. And that’s one reason why our government is bailing out some of these big financial institutions. Everything is intricately connected to everything else.

I recommend that we save more in conventional savings accounts and CDs. Why? The common reasoning goes that savings banks only pay a puny rate of interest and thus will not grow our money. Putting our money in savings banks will ensure that our savings do not keep up with inflation. And so on, and so forth. But all along, I have had my doubts about this line of thought. The thing is, a savings account at an FDIC insured bank is safe. How long would my savings have to sit in a bank to be seriously affected by inflation? Is it the length of time I save or just being exposed to inflation at a certain moment? In other words, if I keep money in ultraconservative, fully federally insured savings accounts until a time when inflation starts happening in a big way, and then switch my money instantly to stocks, wouldn’t I get the best of both worlds? Long-term safety, and short-term gain? And isn’t that what owning a house for decades and then selling it in an up market achieves?

Not so long ago, our current president was touting privatizing Social Security and wanting to put all that money in the stock market, too. That would have been a disaster, especially considering what has been happening with the investment business lately. Each of us could then go broke in two different ways. And I doubt that there would be a federal bailout for the poor suckers whose Social Security benefits were wiped out by investing in BearStearns or Lehman, for instance. This is an idea that is quite dead at the moment. If someone revives it, point to 2008 as a good reason not to go for it.

So what’s the bottom line here? The usual, of course: Live within your income and make a point of saving. If you can. Save even if it means denying yourself something that you want today. Then maybe you will have money for things you actually need tomorrow. Put some of those savings into utterly secure accounts such as FDIC insured CDs with short terms or conventional savings accounts, not retirement accounts. The bottom can’t drop out of those, nor will you have to pay an IRS 10% penalty tax to get at your money before age 59 ½. Make sure that some of your money is available with no penalties at any time. As always, visit a half-dozen savings banks (including online banks) to get competitive quotes on terms and rates.

1 comment:

Savings Bond Calculator said...

I think you have provided some valuable tips about how to be safe during this financial crisis. What I personally feel is that financial insecurity of investment is always there no matter whether the market is in a financial crisis or not. There's bound to be some unpredictable fluctuations due to many unforeseen reasons. The best we can do is just keeping our eyes open.