FDIC Falls Into the Red

Yesterday, the FDIC said the fund which protects consumer bank deposits has fallen into the red and will remain there until 2012. This has only happened once, in 1991 during the savings-and-loan crisis, and it shows how U.S. officials may have underestimated the impact of the credit crisis on the government's cash needs.

Most experts believe the banking crises has yet to hit bottom. "Though some of our largest bank failures have already taken place, there are still hundreds and hundreds of banks that are going to fail in this cycle," said Gerard Cassidy, a bank analyst at RBC Capital Markets. The FDIC had 416 banks on its "problem" list at the end of June, and the number is expected to grow.

The FDIC has already taken more than $30 billion out of the fund to cover bank failures over the next year. On Tuesday, government officials estimated that bank failures from 2009 through 2013 will cost the FDIC $100 billion. FDIC officials estimate the deposit insurance fund wouldn't be back to comfortable levels until 2017.

However, it is important to note that FDIC officials stressed that the fund's depleted state wouldn't affect depositors because federally insured deposits are backed by the full faith and credit of the U.S. government. Essentially, the government will do what is necessary to make sure depositors are paid, whether that is infusing the FDIC fund with cash or printing more money.

The FDIC also has a plan to address the problem. On Tuesday, it proposed the unprecedented step of having the banking industry prepay $45 billion in fees by the end of the year to give the government more breathing room to handle future bank failures. The FDIC is asking most banks to hand over their deposit-insurance fees for 2009 through 2012 by the end of the year.

Surprisingly, most banks liked the idea. It seems they would rather prepay their fees rather than be hit with an emergency charge of $5.6 billion on top of their regular fees...

To relate this information to financial planning, the point is that investors should remember that we aren't out of the woods yet. We had a great third quarter (the S&P 500 is up approximately 15% from July through September), but investors need to be aware of the risks that are currently prevalent in the marketplace. Now would be a great time to re-evaluate your tolerance for risk and ensure your portfolio reflects that risk tolerance. As usual, I recommend speaking to an independent fee only financial planner for assistance with accomplishing these tasks.

Fill Your Buckets - Utah Business Magazine

I wrote an article appearing in the September issue of Utah Business Magazine which describes how to merge your investment portfolio with your daily cash flow management. The article, titled "Fill Your Buckets: Ensure Liquidity in Investment Portfolios," explains the benefit of specifying the short, medium, and long-term portions of a nest egg. Swing by a news stand and pick up a copy. Of course, any feedback is welcome.

As always, its best to speak to an independent fee-only financial planner to learn how to best apply this strategy to your situation.

An Argument Against Home Ownership

Today, it was reported that the median price of a single-family home dropped 2.3% in August. The stock market sold off on the news. For some perspective into the all-important US real estate market, this chart illustrates the US median price of a single-family home over the past 39 years. Housing prices increased at a rapid rate from 1998 to 2006, approximately 7.37% annually after adjusting for inflation. However, housing prices are currently 30% off their 2006 peak.

Putting dollar figures to these percentages, a home purchased for $25,000 in 1970 would now be worth approximately $176,800, an annual return of 5.14% (only 2% after adjusting for inflation). By comparison, an investment in the S&P 500 over the same period would have achieved a 10.32% annual rate of return, (7% after adjusting for inflation). Thus, a $25,000 investment in the S&P 500 in 1970 would now be valued at $349,870.

Two-Thirds of Investors Don't Have a Financial Plan

Despite increasing pressure to slash debt and rebuild retirement funds, two-thirds of consumers do not have a written financial plan, according to the 2009 National Consumer Survey on Personal Finance.

The survey, released today by the Certified Financial Planner Board of Standards, found that 64% of respondents do not have a written financial plan in place, despite studies conducted by the SEC that indicate that on average, investors with a financial plan have twice as much cash and investable assets as investors without a plan.

Investors with a college degree, higher household incomes and more assets to invest are more likely to have a plan. Of the 284 respondents who have a written financial plan in place, 62% were motivated to develop one because of retirement goals and planning. Meanwhile, 48% wanted advice on a broad range of financial matters, 41% were focused on savings goals and planning and 36% were concerned with investment goals and planning. The CFP Board of Standards spoke to 1,742 respondents in total.

“Those in the know who are using financial planning are finding it a valuable experience,” Eleanor Blayney, consumer advocate for the CFP Board, said in an interview. “There are just too many people who are not using it. It’s important to develop a healthy baseline [financial plan] and not just use it in times of crisis,” Blayney says.

When developing a financial plan, be sure to speak with an financial planner that can be objective and focus on your best interest. Unfortunately, many financial advisors develop a financial plan after only a 10 minute conversation with their client, and the plan functions more like a sales presentation than a comprehensive financial guide. It's best to speak with an independent fee-only financial advisor who has achieved the Certified Financial Planner designation to ensure your plan is holistic, comprehensive, and functional.

How Much Slack is in the U.S. Economy?

The past six months would indicate the U.S. economy has bottomed out and begun to turn around. All leading indicators are positive, and trailing indicators are coming in relatively strong, compared to the downturn. However, there is a lot of room for growth. These stats provide some insight into how much the U.S. economy must grow to regain its position as a global leader:

• Hotel occumpancy rates were 56% through July, the lowest since at least 1987.
• An estimated 2,535 aircraft world-wide were in storage in July --14.2% of the world's fleet. That percentage rivals the months after September 11, 2001.
• 501,472 freight cars were in storage at the beginning of September, roughly one-third of the nation's fleet.
• 18.7 million homes were vacant in the second quarter, up from 15.9 million four years ago.
• In August, 14.9 million Americans were unemployed, and 26.3 million were underutilized.
• The Fed estimates factories were operating at 66.6% of capacity in August, far below the 79% average over the past quarter-century.

Overall, the Fed believes the U.S. economy could be producing roughly $1.2 trillion more in goods and services than it is currently producing without straining its resources. Investment markets may have potentially already priced in the U.S. economy picking up this slack. If these expectations are not met, the decline in stock market values may not be over.

How do these figures impact your retirement plan? Speak to an independent fee-only financial advisor to determine what you should do to ensure your nest egg is protected and positioned to meet your specific financial needs.

An Update on Pension Plans and Social Security

Melanie Waddell of Investment Advisor magazine recently provided updated data concerning the continued viability of corporate pension plans and Social Security:

A new study by global consulting firm Mercer has found that the funded status of pension plans for S&P 1500 companies fell again in July for the third consecutive month. According to Mercer, "although equity values are increasing, so is the value of plan liabilities so the net impact in July was a decline in funded status." Mercer found that the funded status of pension plans sponsored by S&P 1500 companies currently has an aggregate deficit of $269 million, which would mean plans could only afford to pay out 81% of liabilities.

Meanwhile, other troubling news about Social Security was released in August by the Congressional Budget Office (CBO). The CBO stated in its long-term Social Security projection that without changes in law, the Social Security trust fund will be exhausted in 2043. At that point, the amounts that could be paid would be about 17% less than those scheduled under current law.

The CBO states that "Social Security's annual revenues currently exceed its annual outlays, but as the baby-boom generation continues to age, growth in the number of Social Security beneficiaries will pick up, and absent legislative changes, outlays will increase much faster than revenues."

Finally, a quick measuring sticks for your 401(k) balance: Among all families with a defined contribution plan, the median plan balance was $31,800 in 2007. Seems like the American public still needs to develop better savings habits.

Is Diversification Back?

Many financial advisors are currently trying to attract clients by offering non-traditional methods of investing. They justify these non-traditional approaches by claiming diversification among common asset classes is no longer effective.

Admittedly, diversification did not protect investor's portfolios in 2008. The performance of all equity asset classes - such as large cap, mid cap, small cap, international, growth, and value stocks - declined in value between 34 and 43 percent in 2008. Thus, regardless of the equity classes within your portfolio, your losses were similar to other equity investors during the recent market pullback.

Does 2008 indicate that diversification is dead? Let's examine how different asset categories have performed since the market turnaround on March 9, 2009:

Large Growth (measured by the Vanguard Growth Index): +51.08%
Large Value (the Vanguard Equity Income Index): +54.89%
Mid Growth (the Russell Mid Growth Index): +63.74%
Mid Value (the Russell Mid Value Index): +76.55%
Small Growth (the Russell 2000 Growth Index): +69.63%
Small Value (the Russell 2000 Value Index): +76.26%
International Growth (Vanguard International Growth Index): +74.63%
International Value (Vanguard International Value Index): +74.73%

Corporate Bonds (the Vanguard Corporate Bond ETF): +6.38%
Government Bonds (the Vanguard Government Bond ETF): +0.65%
International Bonds (the Vanguard International Bond ETF): +19.00%

Obviously, all equity asset classes have rebounded well. However, there is a 25.47 percent different between the top performing equity asset class (mid value) and the worst performing equity asset class (large growth). This is over only a six month period. Consequently, it is clear there has been a large amount of variance amongst the performance of the various equity asset classes during the recovery. I believe this is evidence that the traditional diversification strategy driving traditional financial planning methods is as relative and vital as ever. Don't be tricked into believing the short-term, non-traditional approaches currently being promoted by financial planners who will say whatever it takes to get your business.

Chart of the Day: The Dow / Gold Ratio

For some perspective on the current rally that began back on March 9th, today's chart presents the Dow divided by the price of one ounce of gold. This results in what is referred to as the Dow / gold ratio or the cost of the Dow in ounces of gold. For example, it currently takes 9.7 ounces of gold to “buy the Dow.” This is considerably less (78% less) than the 44.8 ounces it took to buy the Dow back in 1999. Since 2007, the Dow / gold ratio has declined at an accelerated pace (see dashed lines). As a result of the recent rally, the Dow (priced in gold) has moved up significantly and is currently testing resistance of its accelerated downtrend.

What to Do Now?

These financial planning tips never go out of style.

DO:

• Have a financial plan documenting where you want to be and how you are going to get there.
• Have an investment policy statement detailing how you will make investment decisions. This will prevent you from making emotionally-charged investment choices.
• Work with a financial planner who is compensated to provide objective advice, not an advisor who is compensated to sell products.
• Whenever possible, invest early and often. This forces dollar-cost averaging.
• Identify your risk tolerance before the next market pullback, and have an asset allocation that reflects that risk tolerance.
• Be truly diversified among large, mid, small, international, growth, and value stocks. Invest not only in corporate bonds, but government and international bonds.
• Make your asset allocation more conservative as you age.
• Rebalance your portfolio annually.
• Have an ongoing relationship with your financial advisor. Meet with him or her at least every six months.
• Update your financial plan and estate documents at least annually.
• Maintain liquidity in your portfolio. Having cash available will reduce your need to sell securities when their values are depleted.
• Take advantage of the full employer match on your 401k.
• Understand the risk/return relationship of all your investments.
• Understand how and how much your advisor is compensated.
• WORK WITH A FIDUCIARY - someone who is obligated to act in your best interest.

DON'T:

• Necessarily trust your financial advisor. Make him or her earn that trust.
• Let emotion get the best of you.
• Be enticed by new, short-term investment strategies.
• Trust "financial advisors" that encourage you to leverage your home, or push annuity products without mentioning the costs of such products.
• Neglect estate planning.
• Work with a financial planner who isn't financially motivated to constantly serve you.
• Pay high investment fees or commissions.
• Invest in things you don't understand such as gold, commodities, and options.
• Seek advice from friends and family who are not financial professionals.
• Seek advice from "financial advisors" with few tools, such as insurance or annuity salesmen.
• Use short-term investments for long-term goals, or vice versa.
• Invest for the long-term without an established emergency fund (3-6 months of expenses).
• Purchase loaded products.
• Work with a financial wolf in sheep's clothing (an advisor who is not a fiduciary).
  

Chart of the Day

Today, the Labor Department reported that nonfarm payrolls (jobs) decreased by 216,000 in August. Today's chart puts that decline into perspective by comparing job losses during the current economic recession (solid red line) to that of the last recession (dashed gold line) and the average recession from 1950-2006 (dashed blue line). As today's chart illustrates, the current job market has suffered losses that are more than six times as much as average (20 months after the beginning of a recession). In fact, if this were an average recession/job loss cycle, the number of jobs would have begun to increase five months ago.