Wednesday, April 2, 2008

Is US Banking System a House of Cards? (March 2008)

Is US Banking System a House of Cards?

Bear Stearns, one of the largest wirehouses (i.e. stock brokers) in the country tanked this past weekend. That means their stock ended up being worth a little more than a penny on a dollar, dropping from ~ $170 to $2 per share. Shareholders, 1/3 of whom were employees, basically lost everything as JP Morgan bought up the pieces for peanuts.

This raises some questions inquiring minds want to know:

1) Is the US Financial structure about to fold like a house of cards? No. None of Bear Stearns clients lost any money in their brokerage or money market accounts (unless, of course, they owned Bear Stearns stock). Customers’ accounts were transferred intact to JP Morgan. Federal regulations require that clients’ accounts be segregated from firm assets, and are protected by creditors. Details of additional insurance coverage were reviewed in my last email. I personally spoke to Schwab’s compliance attorneys and am satisfied that our clients accounts are well protected. It is large financial institutions that incur the losses with these failures; retail customers such as our clients have never lost any money through the failure of large brokerages.

2) Where should I be investing now? Interest rates have been falling, real estate went bust in most locales, the stock market trends down (although it was up 400 points on Tuesday), gold appears to be in a speculative bubble. Cash looks pretty good right now, even as money market rates are just over 3%. I think dollar-cost-averaging into the stock market will pay off long term. Avoid making any illiquid investments (e.g. real estate, business ventures, etc.).

3) Are the days of a comfortable retirement gone for good? No = the key is balance. A portfolio properly balanced with bonds & cash, real estate, and a diversified stock portfolio will endure. You are protected against deflation, inflation, and still poised to participate in times of prosperity.

4) How long will this last? I’m not a market timer. I am concerned about clients surviving the downside. Things could get worse economically if the municipal bonds market collapses, and there are indications it may. So balance is more important than ever, and trying to guess which way to jump not only produces insomnia, but has been shown to be an almost certain road to lower investment returns. Over the past 20 years, as the market has risen 12%+ per year on average, the average investor has only earned 8% on their stock portfolios. The lower returns are contributed to by higher costs and higher taxes, but most of all are due to clients jumping in an out of the markets. The real costs are in the angst and anxiety of focusing on ‘the market’ rather than ‘the future’ = that’s why you have Stripped Treasury Bond Ladders!

Remember, if you decide to get out of a dropping market, you have to make two decisions right: when to get out, and then when to get back in. Clients who just stay put don’t have to agonize about either, and ten years from now will be farther ahead. Please call us if you have any questions or want to discuss your situation.

Bert Whitehead, MBA,JD

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