This article from the November issue of SmartMoney Magazine was updated for online publication on October 22, 2008.>
Mark Smith, an insurance> agent in Highlands Ranch, Colo., spends a lot of time helping people protect themselves from risk. But these days he s got his own risks to worry about thanks to the Wall Street credit crisis rippling across the country. Earlier this year the mortgage company that holds his home loan, Countrywide Financial, saw its stock crash and got taken over. Now Smith is worried about what could happen to his credit rating if one of his payments gets misplaced by the new management. That s not all: He also holds business and personal accounts with a major national bank whose bad-debt woes have turned it into takeover bait. Smith s accounts are insured, but if the bank goes under or changes hands, he may have to notify all the insurance companies that automatically deposit his commissions into his accounts. What aggravation will I have to go through? Smith asks. And if a bank that big can fail, he adds, what bank do I go to?
Someday we may look back on 2008 as the year that changed the way consumers worry about their finances. Blame it on the instability brought about by a roll call of big-name collapses: Fannie, Freddie, Lehman, WaMu, the Bull (Merrill Lynch) and the Bear (Stearns). With so many institutions falling so fast, we ve gone from fretting over our broker fees to wondering who will manage our money when our broker gets sacked; just ask the 8 million customers who recently woke up to the news that their Merrill accounts would soon belong to Bank of America. And even though the Federal Reserve and Treasury are going to unprecedented lengths to bail out the system, some of us are still wondering what s safer the bank on the corner or the back of our sock drawer.
For the most part, economists say this turmoil will ease in the long run as the financial system repairs its most serious flaws. But consumers don t have to wait for Uncle Sam to rescue their own finances. SmartMoney took a look at five of life s biggest financial focal points banks, brokerage accounts, insurance, mortgages and retirement and came up with some simple moves that can protect your money, your investments and your peace of mind. With an eye toward the worst-case scenarios, we ve spelled out how to rely on insurance plans to protect bank and brokerage assets, how to build a crisis-proof credit score, and even how to keep your retirement plans on track. Call it our guide to playing defense.
Your Retirement: Now What?
Nobody feels queasier about Wall Street s Tilt-A-Whirl year than retirees and near-retirees. Even after multiple rebounds and bailouts, America s collective nest egg has shrunk by an estimated $2.7 trillion in 2008. The good news: Most people can keep their plans on track, or at least come close. Here s how:
Watch your balance, not the headlines
Most people close to retirement own a mix of stocks, bonds and cash which means that only a fraction of their portfolio is subject to stock market swings. This fall, when the Standard & Poor s 500 was down almost 40 percent for the year, a portfolio with 40 percent in bonds should have been down only half that much. Bottom line: Your overall portfolio is in much better shape than your bank stocks.
Rejigger your withdrawals
If you re retired, you probably have a plan to increase the amount you withdraw from your account by, say, 3 or 4 percent each year to account for inflation. In this market you may need to come down a notch or even skip that cost-of-living raise.
Work a little longer
Committing to more time at work not five or 10 years, just one or two gives your investments time to recover. According to a T. Rowe Price study, every year you work past age 62 can increase your expected retirement income (from Social Security and investments) at least 6.4 percent. Indeed, putting off Social Security pays particularly well: For every year you wait, your pension payment rises. A 62-year-old making a six-figure salary can get an extra $1,450 in annual Social Security income by waiting a year to collect, and an extra $6,600 annually by waiting three years.
Cash out or stick to your guns?
If you already have enough savings, you may be able to cut your losses, get out of stocks and enjoy your retirement. But for most people, the best advice is to hold tight, because selling will cost you in the long run. The S&P 500 hasn t posted a negative return over any 10-year period in the past 50 years, notes Stuart Ritter, a financial adviser at T. Rowe Price. And most of us need the growth that stocks provide for our rocking-chair years.
Is Your Money Safe?
Should we cue the newsreels from the Great Depression? This summer California s IndyMac Bancorp collapsed, in the fourth-largest bank failure in U.S. history; it was one of 13 failures in 2008 so far, up from three in all of 2007. But very few accountholders lost any money due to the failure. That, of course, is because the Federal Deposit Insurance Corp. for decades has insured all bank accounts up to $100,000 and, this fall, it increased that ceiling to $250,000.
But can that safety net hold if the economy stays shaky? In the case of banks, yes. The FDIC has $45 billion in reserves, about 12 percent less than what regulators think is ideal. But if there is a wave of collapses, the agency can do whatever it takes to cover depositors including raising premiums on healthy banks (of which there are still quite a few) or borrowing from the Treasury. The latter wouldn t be ideal because it would likely fuel inflation, notes Leslie Beck, a certified financial planner in Palo Alto, Calif. But the individual would be taken care of.
Still, stretching the FDIC security blanket becomes more challenging for savers whose cash holdings exceed that $250,000 cap. To begin with, you can open another account at a different bank when your cash balance nears $250,000. For couples who d rather keep as many assets as possible in one place, opening a joint account doubles the protection. Another tactic: Put some cash in a revocable trust in the name of a family member or friend.
For high-net-worth investors with a lot of cash to protect, hopping from bank to bank can get unwieldy. That explains the growing popularity of the Certificate of Deposit Account Registry Service, a network of banks that offers CDs insured for up to $50 million. Funds get divvied into parcels small enough to qualify for FDIC coverage, then distributed across FDIC-insured banks. Demand for these services has surged lately; the number of participating banks grew by 17 percent in the two months after the IndyMac collapse, which makes it more likely that banks near you will be involved. Banks that belong to the network can be found at www.cdars.com.
Although not many people realize it, federal insurance protects their brokerage accounts, too. If a brokerage fails, it s supposed to turn over to customers all securities in the customer s name. In the very unlikely event that doesn t happen, the Securities Investor Protection Corp. guarantees brokerage assets up to $500,000 in securities and $100,000 in cash per customer.
But while your funds may be secure, your relationship with your broker could change. As Bank of America, the nation s largest bank, works through its $44 billion shotgun marriage with Merrill Lynch, the nation s biggest broker, the question is obvious: What type of service can people expect? Similar changes are almost certain to continue on Wall Street, disrupting broker-client ties just when customers could benefit from some friendly reassurance.
If an acquisition lands you with a new firm, your personal broker could be selected randomly, says Bruce Fleet, president of investment advisory Fleet Capital Management. Investors in this situation should check for customer complaints regarding their new broker at www.finra.org. Meet face-to-face and see if you can establish a comfortable relationship. If the shoe doesn t fit, ask your branch manager to reassign you or consider taking your business somewhere else. Conversely, if your current broker joins a new firm, compare the advantages of your old brokerage such as access to funds, interest rates on cash and free trades with those of your new one. The perks may not match up, and now s the time to ask for more.
Analysts expect many of Merrill s famous thundering herd of 16,000 brokers to move over to Bank of America, but not all of them. Bank of America, for all its banking prowess, isn t known as a great brokerage. It ranked 12th out of 16 in our brokerage survey this year, thanks in part to so-so performance in responding to client queries. The bank also charges hefty fees for broker-assisted trades. (A Bank of America spokesperson says that customers being moved should expect the same customer service they were getting with Merrill. )
Since mortgages are what got Wall Street so sick in the first place, it s natural to assume that lenders would shun prospective homeowners like three-day-old sushi. But late this summer, in the weeks after the government seized Fannie Mae and Freddie Mac, 30-year fixed mortgage rates dropped three-quarters of a point, to below 6 percent. Could the credit crisis actually make this a good time to shop for a mortgage?
It s not quite that simple. Most analysts say the mortgage-rate outlook is promising. The reason: Lenders see the mortgage-related catastrophes on Wall Street as a sign of coming stability, believe it or not. Each collapse ultimately serves to remove a level of uncertainty, says Keith Gumbinger, a mortgage analyst with HSH Associates. But getting access to that money will be a lot harder than in the no-money-down days of the housing boom. In 2007, mortgage denials rose for the fourth straight year, to 32.5 percent of all applications, and by all accounts, refusal rates in 2008 are much higher.
Homebuyers will need to come to the table with a down payment of 10 percent or more. Whether they re buying or refinancing, borrowers will need sterling credit to get the lower rates, with a credit score at least near the national median (723, according to Fair Isaac). The best action plan for those who want to borrow: boost that all-important score. Keeping your total revolving debt below 35 percent of your credit limit can earn you 10 to 50 points. You can also gain critical points by opening a new credit card account. And of course, paying on time remains crucial: A single missed payment can cost as much as 75 points.
Speaking of missed payments, as brokerages and banks shed billions of dollars worth of mortgages from their balance sheets, current homeowners may find their payments being processed by a different servicing company. This shouldn t change the terms of a loan, but it could create a hurdle for those who have set up automatic payment plans, since you run the risk of sending a check to the wrong place. Keep an eye on your mail for changes: The new servicer must notify you within 15 days of taking over the loan and for the first 60 days, you can t be charged a late fee if you mistakenly pay the old firm.
Statistically, insurance company failures are rare. Over the past three decades, somewhere north of 650 insurers have become insolvent a fairly small number compared with the 7,773 U.S. insurance companies in business as of 2007. Still, in the current credit crisis, there s no such thing as a sure thing. Ever since the bailout of industry giant American International Group, policyholders have been wondering whether their insurers could be the next big institutions to knuckle under.
The good news is, just about every insurance policy on the market has a backstop, in the form of state guaranty funds that will back up the policies if their carrier goes belly up. In the case of property, auto, small-business and home insurance, every carrier licensed to operate in a state must be a member of that state s guaranty fund. If a member company is declared insolvent, its policies are taken over by the state fund, which pays any covered claims. For life and health insurance and fixed annuities, the process is a bit different. In most cases state associations will cover the policies until they can be transferred to a financially healthy carrier, which will honor the policies original terms.
The state associations can t solve all of a policyholder s problems, however. Most states have coverage limits of $300,000 on home and life policies and if a policy gets transferred or taken over by the state fund, it s guaranteed only up to those limits. And those ceilings are often too low to protect someone with a new home or a young family. If your policies are more valuable than your state s limit, it behooves you to switch carriers before your insurer hits the skids. To monitor a company s health, check the web site of rating agency A.M. Best, which posts press releases whenever it bumps an insurance carrier s credit rating up or down based on the company s financial position.
Keep in mind that jumping ship of your own accord may cost you. Property and home insurance can be canceled easily, but some life policies and annuities levy penalties for exiting a policy. Consumers should also consider their insurability if they want to switch life or health coverage. Someone who developed diabetes after he took out his current policy, for example, would be hard-pressed to find a new policy without paying much more.