Your Piggy Bank

47

Your Piggy Bank

What are banks for?

To make money.

For the customers?

No, for the banks.

Why doesn’t bank advertising mention this?

It would not be in good taste. Now go off and open a bank account.

Wouldn’t I do better to go off and open a bank?

Feeding Your Piggy Bank

The Federal Reserve (the Fed) determines what banks charge each other for short- term overnight loans to each other (the federal funds rate). They indirectly influence what banks will pay for borrowing money from the Fed itself (the discount rate), what banks charge their best customers (the prime rate), and what banks must pay to the Federal Deposit Insurance Corporation (FDIC) for a type of insurance in case the bank fails.

Without you, banks have no money to loan. But because they don’t remind you how much you are needed, you may be intimidated by the local shrine where they keep the vaults and (supposedly) the large piles of cash.

G

ET

R

ICH

S

LOW

48

When the Fed wants to stimulate the economy, it can lower the federal funds rate, demand that banks sell securities to them in exchange for money, and expect that lenders will loan out this extra money at lower rates to bank customers.

But nobody explained this last part to bankers. With bank deposits and interest rates the lowest in nearly 50 years, some credit card interest rates are as high as ever.

Credit card borrowers with a poor credit history, who can’t transfer to cards with lower interest rates, may pay even more, though interest rates on mortgage and other loans are among the lowest in nearly 40 years. Knowing that these consumers are trapped in minimum monthly payments, lenders can charge rates as high as their states and usury laws allow.

Piggy Banks Act In Their Own Interest, Not Yours

Why do we believe that lending institutions are our friends? Because they package their deals to look like gifts. By advertising a lower mortgage interest rate, then adding points, closing costs, and other fees, customers thinks they have saved money while, in truth, they have likely purchased a larger debt by refinancing their home. Most folks don’t pay the extra costs such as points and closing fees with up-front cash. They are added to the new loan amount. If the institution can pitch disability, life insurance contracts on auto loans, and private mortgage insurance (PMI), the institution can sell more products to the same customer. That strategy is called cross-selling and it is very profitable for the bank.

And to add more to their profits, banks now charge for services that used to be free, such as ATM usage, low-balance accounts, check-cashing, returned checks, and monthly clear- ing service charges.

I Get No Respect

Rodney Dangerfield made this line famous. There are millions of Rodneys firmly ensconced in passbook savings accounts paying low rates. Customer inertia keeps money in low-yielding accounts.

The primary purpose of bank products should be safety of principal, not yield. Short- term bank deposits can be a foundation for your investment portfolio (like the foundation under your home) to cushion the ups and downs of securities markets. Both Savings and Loan Thrifts and commercial banks can be backed by the FDIC today. Shop for the best short-term products and be sure they are FDIC-insured. Technically, the FDIC is not the U.S. Government, but instead, one of its agencies. As a result, it is assumed that Wash- ington, D.C., would step in and refill empty bank coffers should a banking disaster of major proportion occur.

Most bank customers understand basic products such as savings accounts, NOW interest-bearing accounts, and CDs. Avoid brokerage CDs, callable CDs, or CDs offered by bank credit card companies. Brokerage CDs may pay more, but they may have long

05 GRS Chap 05.pmd 48 1/16/2004, 3:51 PM

lock-in periods not disclosed to you at the time of sale. There may also be a huge penalty for early withdrawal. Callable CDs can be terminated early by the institution. So you have no control of how long you can lock in an attractive interest rate. There may be enormous penalties for early withdrawals, as some callable CDs don’t mature for 20 years or more.

Confine your banking to your own neighborhood where you may hear information to alert you to an institution’s financial troubles. If your CD is from your credit card com- pany bank in Alaska or Texas cow country, you won’t hear what’s happening to the insti- tution or the local economy and you won’t have the opportunity to protect yourself. Time deposit periods vary between bank institutions.

Can You Bank On It?

Are your bank deposits safe? Generally, the FDIC insures deposits up to $100,000 per depositor, per financial institution. (A bank with five branches is one institution, not five.) However, the rules can get tricky with different types of accounts and multiple accounts held at the same institution. Ask for the deposit insurance rules before setting up an account. Don’t get greedy by trying to register accounts differently to take advantage of some type of special rate. You could be ruining your estate plan. If a banking industry failure should ever occur, it may take some time to sort out customers’ liquidation op- tions. So diversify your savings among several institutions. Even a short-term bank clos- ing could crimp your lifestyle. Stash some emergency cash at home (small bills only) to pay daily bills (food, gasoline, or utilities) until your government makes your bank depos- its available.

CD Strategies

During periods of falling interest rates, it may be wise to lock in longer CD maturi- ties. When interest rates are on the rise, however, the opposite strategy may work better.

Short-term maturities of 30 days or less allow depositors to reinvest at higher rates when interest rates are climbing. Predicting the direction of interest rates is a losing game, however, even for the experts. You may be able to see a trend—up or down—developing to tip you off whether to lock in your deposits for a longer time (if interest rates look like they are declining) or use shorter time deposits (if interest rates are on the rise), and you don’t want to be locked in at a lower rate when you could have higher interest on your money in just a few months.

Today’s short-term interest rates are so low and so volatile that I currently recom- mend CDs maturing one month or sooner along with liquid accounts that have no time lock-ins. Don’t tie up your savings in long-term time deposits unless a banking institution allows you an emergency escape hatch in writing (such as allowing you to withdraw your IRA CD without penalty because you are older than age 70).

G

ET

R

ICH

S

LOW

50

Work In Your Own Interest

Request a brochure for short-term savings products and cost-effective checking op- tions before buying any bank product. Bank personnel may be motivated by commis- sions, quotas, referral fees, or other rewards for selling certain bank products. Some employees have monthly sales quotas to meet. They are working in their own self- interest. Employees are paid to earn profits for the bank, not to impart customer strate- gies to beat the bank at its own game. Bank safety and competitive interest rates should be your priority. Convenience, friendliness, or ATM machines are secondary issues.

Beware of high yields that sound too good to be true. An institution may be experi- encing temporary solvency problems or soliciting funds for short-term operational ex- penses. There is little real money in the vault. It has been loaned out to strangers (whose names you do not have) in the hope they can maintain a job long enough to pay it back with interest. You are interested only in guaranteed money.

Be sure to diversify your banking activities. Weigh paying service charges on a “regu- lar” checking account with “free” checking offers that require a minimum balance. You may be able to net more money by paying service charges on one bank product while depositing other funds with a competitor.

Don’t put large amounts of savings into the same bank through which you have your mortgage or other loans. Your contract probably states that they can grab that money if they fear you are either an impaired risk or you cannot make your regular monthly loan payments. If a bank should shut its doors, and funds for your monthly mortgage payment comes out of the same bank, how will you make your monthly mortgage payments?

Don’t accumulate more funds than necessary in required minimum balance accounts if you can do better elsewhere. Deposit only enough money to get the “free” service or benefit unless the yield is competitive.

Ask how minimum balance accounts and interest rates are calculated to avoid penal- ties. If your account value dips below a minimum for just one day, you could be charged a low balance fee.

As Safe As Money In the Bank

Don’t confuse FDIC-insured bank money market accounts with money market mu- tual funds sold by the bank but not FDIC-insured. Money market mutual fund pros and cons for short-term funds are discussed in Chapter 17.

Not all CDs are backed by the FDIC. Private corporations can create debentures (IOUs) or “certificates” backed only by the bank’s assets. Promissory notes can also be sold as “safe.” A higher-advertised yield is not necessarily smarter banking. Ask if your CD will be insured by the FDIC. Get the answer in writing. Look for an FDIC insurance sign on the institution’s exterior doors or near the teller’s window. Don’t assume that all

05 GRS Chap 05.pmd 50 1/16/2004, 3:51 PM

products sold inside the building or by the company will be FDIC-insured against loss of investment principal.

Bank IRAs and Rollovers

Short-term funds should guarantee your principal. Long-term money should guaran- tee your purchasing power. IRAs are long-term money that must outpace inflation. Bank CDs sold as IRAs lose the race against inflation over time. IRAs represent long-term money, and their primary goal should be conservation of purchasing power—to match or beat the damaging effect of inflation on your money.

Lenders spread the news about the benefits of IRA accounts, but they seldom tell customers about inflation-fighting mutual funds. IRA accounts must protect future pur- chasing power. At the next deposit maturity, consider transferring your funds to conserva- tive mutual funds so the tax-deferred benefits of an IRA account can work even harder.

Collateralizing a CD for a Loan

Suppose you want to pay cash for a used car and you stop by your lender to withdraw your $10,000 CD. Your lender may discuss another option with you. If you take out your CD, he advises, you will lose the future interest (say, at 5 percent) that you could make on that investment. If, instead, you keep your CD intact and use it as loan collateral, you could borrow $10,000 for the car at 8 percent—only 3 percent higher than your CD is paying, he continues. An 8-percent car loan minus the 5-percent interest from your CD is like borrowing at 3 percent, almost stealing from your lender. Really? Let’s examine what’s going on here.

The formula for compounding the annual effective yield on your CD is probably quarterly, while the interest on a simple loan at 8 percent is compounded monthly. The difference between the interest on the CD and the interest you pay on the loan will be larger than what the simple interest sales pitch implies.

You are borrowing at 8 percent, not 3 percent. This sales technique is called anchoring—

fooling you into thinking that the loan is less expensive. Your best option is to pay cash for the car, even though you will lose the interest on your CD. You would lose even more money in the end if you financed the car at a higher rate than your bank CD is paying. A collateralized CD is hostaged anyway, until full payment of the loan has been made. So you don’t have access to your CD money until the loan balance is paid off.

The lender keeps your deposit on site, talks you into an additional loan, and has pro- tective custody over your CD for a longer period of time.

If you pay cash for the car, then start directing the same monthly payments you would have sent to the lender into your own account, you will be richer at the end of the pro- posed loan period.

G

ET

R

ICH

S

LOW

52

How Can I Charge You?

Let us count the ways: home mortgage loans, home equity loans, auto loans, credit cards, credit card transfer balances, return check charges, low-balance account fees, ATM fees, brokerage fees and commissions, and monthly service fees.

If your bank charges fees for services you believe should be free, complain to man- agement. If your complaint falls on deaf ears, move your business to a cheaper institution.

Good financial consumers shop for money carefully.

This Little Piggy Now Has Roast Beef

Some banks have entered the insurance and investment business with insurance an- nuities and other CD-like investments. The operable phrase here is “CD-like.” No CD- like investment is backed by the FDIC. This is marketing hype.

Watch out for a sales pitch similar to this one:

“We are _______________, and although we’re not really the bank, we are very closely associated with the bank, and even may be owned by the bank. We would like to show you our CD alternative we sell here in the bank building. It is not insured by the FDIC, but we have researched it and feel that this company is very safe for your money, or we certainly wouldn’t be show- ing it to you.

“It has a much higher return than our bank CDs can offer—and look at all this tax-free income you’ll accumulate every year until you take it out!

And if you never take it out, the money will keep compounding tax-free until it goes to your heirs, probate-free.

“You certainly qualify for tax relief plus the higher interest rate.

“We don’t want to push you into anything. We especially don’t want to restrict you to the bank’s low yielding, taxable CDs.”

Most customers are going to remember three things from this sales pitch: safe, high yield, and tax free.

Investments sold on bank premises that are not bank products are not backed by the bank or by the FDIC, even if they mention words such as “safe” and “guaranteed.” No mutual fund, insurance annuity, bond, or stock is FDIC-insured.

Just because a product is sold on bank property, by a bank employee sitting on bank furniture, and sold on forms provided by the bank—even managed by a company that may be a bank subsidiary, with the bank getting part of the product commission—doesn’t mean that this sale has to be bank business. (How could you make that kind of mistake?)

05 GRS Chap 05.pmd 52 1/16/2004, 3:51 PM

The Investment Expert

Your banker wants to manage your money. Banks have acquired mutual funds and brokerage houses. They want management fees, too. Some may market managed ac- counts, while others pitch their own brand of mutual funds, insurance annuities, and individual securities.

The credentials of the salesperson may be limited to a sales license (vice president means little), relying on the credibility of the institution to bring in customers. Some may let you believe that because their products are sold on bank property, your investment principal is safe. Separate your banking and investment needs. Even if they know more than you will after you finish reading this book, they are simply selling investment prod- ucts, not advising you in your best interest.

Diversify your savings into several banking institutions, and remember to stash a little “green” at home, just in case.

This page intentionally left blank