Who Can Benefit from the New myRA Account Introduced by President Obama

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In his 2014 State of the Union address President Obama introduced the myRA account and said that the Treasury was taking action to make it available by the end of the year. The account will offer a decent rate of return for a federally guaranteed savings product but comes with some limitations.

In his 2014 State of the Union address President Obama introduced the myRA account and said that the Treasury was taking action to make it available by the end of the year. The goal of the plan is to help millions of Americans save for retirement.

myRA Details

Although the details are still being worked out, the following information has been released about these accounts:

  • All workers who have household income below $191,000 may invest in the plans.
  • The plan will work like a Roth IRA, where after-tax money is put into the account and the money can be withdrawn in the future with all gains becoming tax-free.
  • The only investment option is a fund of U.S. Treasury Securities. Because the securities are backed by the government, a saver will theoretically never lose their principal.
  • The White House says the plan will earn the same rate of return as Thrift Savings Plan's Government Securities Investment Fund that it offers to federal workers. That fund earned around 1.5 % in 2012. Its average return between 2003 and 2012 was 3.6%.
  • Principal can be withdrawn from the plan at any time penalty free although if interest earned is withdrawn before age 59 ½ it will be taxed.
  • Initial investments can be as low as $25 and workers can contribute as little as $5 at a time.
  • Individuals will be able to contribute $5,500 per year.
  • The maximum that can be saved in the account is $15,000. Once that limit has been reached, the excess money can be rolled over into a private IRA fund.
  • Workers can keep the plan even if they switch jobs.

The account is aimed at individuals who have not started saving. Those in high income brackets are ineligible. The rate is actually not that bad when comparing it to other no risk investments such as savings accounts and CDs. The 1.5% 2012 return is far higher than any savings account at the moment, and the money accrues tax free, boosting income even more. The best 5 year CD rates pay between 2-2.5% APY. The money is safe and protected and the principal is liquid, although the interest cannot be withdrawn without penalty.

Those who have never saved before might find this a relatively pain-free way to begin socking away money. From the myRA account, first-time savers can always graduate to private IRAs with more options.

Those under 50 who have access to other investment options should probably invest their money more aggressively in a mutual fund IRA that has the potential for much higher returns.

Those fifty and over who are looking to sock away some safe money until retirement might look at this account. The maximum that can be saved in the plan is $15,000, so it’s not going to significantly change a portfolio, but it’s an easy way to earn a decent tax-free return and keep money liquid.   


How You Could Be Impacted if the Fed Initiates "Surprise Inflation"

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The Fed is still trying to stimulate the economy, including raising the inflation rate. Could it use a theoretical concept called "surprise inflation" to shock the economy and give it a lift? How would "surprise inflation" impact savers and borrowers?

Occasionally, BestCashCow likes to conduct thought exercises that explore various economic theories and topics. The article below explores the Barro Gordon concept of "surprise inflation" and how the Fed may want to turn to it should inflation rates and the economy remain depressed.

Since its rollout in 2008, Quantitative Easing, or QE as it’s known, has been met with mixed to negative reactions among the economic community.  One goal of QE was to raise long term inflation expectations (increase inflation means an increase in interest rates to compensate), which happened initially but has tapered off in recent months. The Survey of Professional Forecasters shows inflationary expectations holding steady around 2%, but you have to take that with a grain of salt as it relates to extrapolating those expectations outwards onto the entire population. In either case, neither set of expectations displays the increase The Fed was hoping to achieve. This is quite extraordinary. Since the financial meltdown in 2008, despite all of its heroics, the Fed has not been able to successfully increase the inflation rate and is still in many ways battling with a deflationary environment.

In my last semester at Penn I took an economic theory course on money and banking where we took a model by Robert Barro and David Gordon on inflation and adapted it to talk about optimal debt levels and policy. The original 1983 Barro-Gordon Paper, “Rules, Discretion and Reputation in a Model of Monetary Policy,” deals with the government’s incentives and policy options as it pertains to manipulating the inflation rate. There’s a lot more to the model than I’ve included below, and it’s worth checking out if you’re interested, but I’ve tried to capture the flavor of the paper in a concise manner. The paper provides a theoretical framework for one way that the government can stimulate the economy.

If the government believes that distortions, from items such as income taxation and unemployment compensation, have lowered production and the amount of privately-chosen work below acceptable levels, the government may want to take action. By raising the inflation rate above expected levels (“surprise inflation”) the government can depress the value of real wages and theoretically stimulate economic growth. Additionally, surprise inflation lowers the government’s future real expenditures for interest and repayment of principal, essentially allowing it to “raise” money without having to resort to taxation. The tradeoff here is that in using surprise inflation, the government takes a hit to its reputation and receives “punishment” for a given length of time, resulting in a less than desirable and more costly equilibrium since people adjust their expectations. Which route the government chooses depends on a few different factors, namely the punishment interval they must endure before their reputation is restored, the last of which Barro-Gordon indicates in an optimal contract with the people, would be for finite amount of time.

The argument could be made that by using surprise inflation, they could, as the paper suggests, stimulate economic growth, lower debts in nominal terms, and increase long term inflationary expectations (one of their original goals). Whether they meant to or not they did induce a recession (they were not solely to blame, but their complacency played a large role) which lowered inflationary expectations, so the government has set itself up to “cash in” on their “investment”, or “biting the bullet” as Barro-Gordon refers to it. Obviously there are a lot of factors present here that aren’t included in the theoretical environment and the punishment interval as well as the benefit parameters are not clear.

One way or another, the Fed is going to have to find a way out of this monetary, low inflation ditch. The question is what the chances are that the government actually does initiate surprise inflation, and if they do how would they do it and how would it affect your savings? For starters, there doesn’t appear to me be a historical precedent for this type of operation, and it’s not as if the Fed would willingly admit they were looking to surprise the public.  So, don't look for new Chairwoman Yellen to discuss surprise inflation.

As for how the government would increase inflation, there would be a few different ways they could go about it:

  1. Hand out loans to member banks: This doesn't appear as feasible because most banks today have plenty of cash. They are not lending because of a lack of capital or deposits, but rather out of caution and fear of a weak economy, as well as weak loan demand.
  2. Monetize government debt: The Fed is able to create money without printing a bill. They have the ability to buy Treasury Department issued bonds with a check, essentially flooding the economy with the dollar amount of the bond purchase. This is similar to QE, but instead of commercial and private lenders, the Fed is buying from another part of the government. 
  3. Lower the reserve requirement: A slightly more risky proposition, the Fed lowers the bank reserve requirement that banks must keep on deposits. Theoretically, this stimulates more lending. In the past, the reserve requirement has almost never changed because of the perceived fear of disrupting financial markets that can come with a change. Still, if stuck in a bind, the Fed may decide to try it. 

Of the three, the government can most covertly initiate the second and third options. For savers, the increase in the inflation rate would dilute the value of savings and make investments in things that will provide a hedge against inflation i.e. derivatives (options, swaps), precious metals, and real estate wise choices.  This has the potential to create a very explosive rising rate environment and those savers that have money locked in low rate, long term CDs would see the value of their investments eroded. In such an environment, it makes sense to stay liquid.

Borrowers with fixed, low interest loans would fare well but those in any variable rate loan would see significant rate and payment increases.

Will the Fed pursue such a policy to shock the economy? Most likely not. But as we've seen with the multiple QEs, the Fed is trying to stimulate the economy and increase the inflation rate. Whether it will take even bolder steps to do this in the future remains to be seen. In general, the more talk you hear talk of deflation or a lack of inflation, the better the chances the Fed will take unprecedented and surprise moves to shock inflation back to life.   


The Moderately Wealthy Need to Manage Money Differently From the Ultra Wealthy

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A person who has put together $5 to $10 million in liquid assets needs to manage cash differently from someone with $50 million +.

I recently renewed contact with an old buddy of mine from business school who now manages money for wealthy individuals.  When we got down to discussing our career paths and my role as Editor-in-Chief of BestCashCow.com, he became insistent that holding cash in savings or money market accounts and short term CDs is a bad idea.  I believe that he is dead wrong.

Of course, cash has dramatically underperformed a diversified stock portfolio and a diversified bond portfolio for the last few years.  Since you cannot time the markets or the economy, nobody should ever move entirely into cash.  I personally believe that an appropriate portfolio for even the most aggressive, moderately wealthy investor is 40-50% equities, 25% high grade municipal bonds or bank-issued structured notes, and 25-35% cash across accounts at top and well-known online banks.

My friend, however, suggested that instead of holding any cash, I take a look at a series of bonds, bank loans, hedge funds and managed future funds.  He recommended that a moderately wealthy investor should open an account with a money management firm (such as his) and place all cash in the account, accessing a line of credit for any expenses.  In particular, he proposed the following asset allocation as an alternative to FDIC insured savings accounts:

Global Bond Mutual Funds:

Templeton Global Bond Fund Adv 10.00%

 

Multisector Bond Mutual Funds:

Goldman Sachs Strategic Income I  10.00%

JPM Strategic Income Opportunity Select  12.50%

Osterweis Strategic Income Fund 10.00%

 

Bank Loan Mutual Funds: 

Nuveen Symphony Floating Rate Inc 7.50%

 

Diversified Alternative Mutual Funds:

Avenue Credit Strategies Inst  5.00%

Driehaus Select Credit Fund  2.50%

Litman Gregory Masters Alternative Strategy 7.50%

 

Hedge Funds:

Morgan Stanley Absolute Return  15.00%

 

Directional Alternative Mutual Funds:

ASTON/River Road Long-Short I5.00%

Mainstay Marketfield Fund 5.00%

Neuberger Berman Long Short Institutional  Fund  5.00%

 

Managed Futures:

AQR Managed Futures Strategy I 5.00%

 

The above portfolio, with an average annual return of 6.20% since 2009, would have slightly outperformed online savings rates over the last several years; it, however, would not have outperformed a five year CD initiated 2009 or most stock or bond portfolios.   

The problem here is that the portfolio was down dramatically in 2008, and again in 2011.   While it is diversified and conservative, some components have experienced negative quarters at other points in the last five years.   In 2014, importantly, there is a real risk of underperformance again should interest rates rise or should emerging markets continue to falter. 

Were those risks not present, ultra-wealthy investors (which I define as someone with over $50 million) would probably do well to invest a portion of their money in a series of funds like those presented by my friend.  They can easily get into the proposed funds directly with the fund managers (paying only a management fee which is often reduced).  They can ride out the shifts in the market.   And, in the worse case, were one of the funds to fail, they would be able to absorb the loss as my friend’s model portfolio places no more than 15% in any single fund.

A moderately wealthy investor (someone with between $5 million and $10 million in liquid assets) does not have any of those luxuries.  Moreover, without some sort of deep inside connections, they are likely placing their bets through a money manager who will charge a management fee.    For example, a 0.70% management fee would cause the annual return on my friend’s recommended portfolio to fall to 4.60% since 2009.

A 4.60% annual return in a strong economy (versus close to 1% in the leading online savings accounts) is not only not guaranteed but it is just not enough of a premium for a moderately wealthy investor to justify the loss of liquidity, the volatility and absence of FDIC insurance.   In fact, a prudent, yet aggressive, moderately wealthy investor would easily make up the 3.60% annual difference by taking on more risk in their other investment classes (something that they are more apt to feel comfortable doing if they have a cash portfolio, instead of an alternative portfolio of funds with fees on top of fees). 

The fact remains: Cash – particularly in the form of savings accounts divided across several FDIC insured institutions - remains an important base to any portfolio and it is not replaceable by anything else or a collection of anything else.  It is the part of your portfolio that isn’t to be risked.  Having more of it allows you to sleep at night.  It is liquid.  It enables you to deal with life’s traumas (unexpected health care expenses due to loss of health insurance because of Obamacare, divorce, etc.) and to pursue life’s opportunities without stress (private investments, real estate opportunities, etc.).

Don’t pretend to be ultra-wealthy if you are moderately wealthy.   Stick with cash.


Rate Chasing Seems Harmless Enough, but It Can Quickly Become Perilous

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A recent experience I had with an online bank after they lowered their online savings rate demonstrates how perilous rate chasing can quickly become.

For much of 2012 and 2013, a little known online bank offered an outstanding online savings rate that was well above that offered by the other major online banks.  The bank, New York Community Bank (NYCB), operates two online banking brands, Amtrust Direct and MyBankingDirect.com.  I, like many followers of BestCashCow, opened an account with Amtrust during this time and received an interest rate on my savings for more than a year from this bank several basis points above that which I would have received anywhere else.

In September 2013, however, the rate fell abruptly without notice of any sort to customers and all of the sudden depositors in NYCB brands were earning less in their online savings accounts than in accounts at more familiar names like American Express, CIT or GE Capital.  This underscores the first peril of chasing rates: rates on savings accounts can always fall dramatically and without notice.

A second peril came to light when I tried to redeploy money from NYCB to a bank with higher rates.   NYCB’s limitations on numbers of transfers and amounts of money that could be transferred out within a single timeframe made the process of winding down take two months for those who had deposited close to $250,000, the FDIC insured maximum on bank deposits.

To be clear, the bank’s abrupt rate change (during a period where their competitors were actually raising rates as bond yields were rising) and its obstacles to withdrawals were frustrating, but they were well within the bank’s rights.  And, they were necessary and understandable risks that I and many others took to earn a higher savings rate over the period. 

The third peril, however, was not one that I expected to encounter in the chase for the best savings rates. It arose when I stopped short of closing my account after withdrawing almost all of my balance with the bank.  I thought I was being clever by leaving a couple of dollars in my account so that I would be able easily to move money back were they to raise the rate again. Two months later, however, I received a strongly worded note from NYCB stating that they had just instituted a $10 monthly account service fee, resulting in my account having a negative balance.  The letter further stated that the negative balance, if not paid immediately, would result in a closure of my account and the bank reporting “information about your account to credit bureaus, such as Chexsystems” so that  “defaults on your account may be reflected in your credit report”.

I was able  to resolve this issue with the bank by phone, closing the account and avoiding any damage to my credit rating.  Nonetheless, this experience underscores another and perilous pitfall in rate chasing.

You can, however, mitigate these perils.  First, you must follow savings and money market rates closely, checking online with those banks where you have accounts and as well as checking with BestCashCow often to be sure rates have not changed.  Second, you may want to avoid banks that do not allow you to move the balances out quickly (major banks do not impose undue obstacles, but some smaller banks do have monthly limits).  Third, you should always be sure to close an account fully and immediately after you have received your final month’s interest in order to avoid a situation like the one I found myself in.

A Note on FDIC coverage:  Some banks, such as NYCB, operate online banks under multiple online brands.  BestCashCow.com follows an editorial policy of listing only one online brand associated with a single FDIC certificate.   This policy avoids confusion and prevents depositors from unintentionally exceeding FDIC limits.  Since both the Amtrust Direct and MyBankingDirect brands are covered under NYCB’s FDIC certificate, this site is only listed as Amtrust Direct in our rate tables.


Are Bitcoins for You?

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What are Bitcoins and should you get involved with the new currency that is all over the news and media.?

You've already probably heard something about Bitcoin over the last couple months (and if you haven't, you should probably pay some attention) and many are wondering exactly what is Bitcoin and is it for real. Since a Congressional hearing on the currency in November the value of a Bitcoin has soared from under $100 several months ago to over $1,000 today. 

So, what is a Bitcoin and is it something that you should consider getting involved with? Bitcoin is a new type of currency that takes advantage of peer-to-peer technology to facilitate transactions. Like many of the file sharing networks that sprang up around music, it uses connections between individual computers to transfer Bitcoins, or funds, eliminating the need for a central authority - no central bank, no bank, no credit card processor. So, how would a typical transaction work using Bitcoin? 

Anyone can create a Bitcoin by installing software and becoming a Bitcoin miner. A certain amount of work is required for the creation of every Bitcoin, and this amount is adjusted by the network so that the amount of Bitcoins in circulation is controlled and predictable. It's important to note that this is done automatically without the intervention of any central authority. Bitcoins are stored in a digital wallet, and when a transaction is created, the Bitcoins are given a unique digital signature. When you send money to pay for a good or service, the transaction is recorded in the network and the proper ledgers are automatically adjusted. These ledgers are all public, allowing anyone to review the transactions, although the personal information of the sender and receiver is not typically included in these transaction logs. As a result, every transaction is both encoded to ensure it cannot be tampered  and it anonymous, and made public, to ensure that it is executed in an open and transparent way. 

Several private markets have sprung up to allow users to convert Bitcoins to dollars, Euros, or other currencies. It is this conversion rate that has boomed since the hearings. 

So, what are the advantage of Bitcoins? 

  • Zero or low fees. Because there is no middleman, there are very little or no fees associated with transactions.
  • Fast international payments. Bitcoin transactions can be done in 10 minutes from any part of the world.
  • Identity protection. Because there is no credit card number or single number used to key a transaction, there is no chance of having your credentials stolen, like with a credit card.
  • Theft protection. Bitcoins are digitally signed too a user so there is no way to steal a Bitcoin.
  • Universal access. Anyone can pay or accept money via Bitcoin. The system is totally open and the documentation can be read and implemented by anyone.
  • No taxes. Since the transaction is entirely between two individuals, there is no record of the money transfer for tax purposes. Taxes would have to be levied in an entirely voluntary manner.

What are the disadvantages of Bitcoins? 

  • Because money can be sent anonymously, criminal networks and enterprises have begun to utilize the currency to facilitate payments.
  • Boom and Bust. Because no one really understands the value of a Bitcoin, there are wild price swings in the conversion rate of Bitcoins to dollars and other currencies.
  • Not widely accepted. At the moment, only a few merchants accept Bitcoins.
  • Bitcoins can be lost. If a hard drive crashes or a user misplaces their USB drive, the Bitcoins stores on there will be lost. Most experts advise users to store their Bitcoins on a computer device not connected to the Internet and use a backup.
  • No Buyer Protection. If a good is purchases using Bitcoins and the product or service is not delivered as promised, there is no mechanism to enforce refunding of the Bitcoins. Adding a third party escrow service would essentially mitigate the strength of Bitcoin, no middleman.

 Should You Buy Bitcoins?

 If you are just hearing about Bitcoins for the first time and have no desire to actively trade Bitcoins, then I would say know. While the value has shown spectacular growth in the past couple of years, the Bitcoin economy is highly volatile and values could crash any day. No one knows what the future of Bitcoins will be and whether they will eventually assume a widely accepted alternative form of payment, or if they will remain a fringe currency, used by drug dealers and money launderers to escape the spying eyes of law enforcement.

If you're interested in seeing what the future of currency may be about, then it might be worth it to purchase a few Bitcoins, understanding that the value may soar, or may drop like a rock. But it does seem that currency, like music, newspapers, books, and movies is not impervious to the impact of digital technology and the Internet.


HSBC and Societe Generale Offer US Customers Interesting Debt-Side Structured Notes

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I have written several previous articles on this website about Structured Notes. Structured Notes involve real risks. I continue to advocate that those Notes based entirely on equity or currency baskets should be avoided all together in favor of better instruments in the ETF and hedge fund spaces. Nevertheless, I continue to believe that those trying to put money away safely with a long horizon can pick up yield by placing some small part of their assets in debt-side Structured Notes.

As longer term interest rates have picked up in the second half of 2013, we have seen major US banks – particularly Chase, Citibank, Morgan Stanley and Goldman Sachs – come to market with interesting debt-side Structured Notes after having been unable to fund these notes in 2012 and 2013.  US subsidiaries of HSBC and SocGen, two major European banks, have now come to the US market with their own notes.

HSBC’s Structured Note is a 15 year note paying as much as 10% APY (on quarterly payment dates) based on the difference between the 30 year and the 5 year Constant Maturity Swap (CMS) rate note and is very similar to the recent Citibank offering that I wrote about earlier.  This Note, however, is slightly more favorable than the Citibank offering in two respects.  First, the HSBC note is only callable at the first anniversary of its issue and at the eighth, not quarterly after the first year like the Citibank Note.   Second, the Note offers 4.25x the 30 year CMS over the 5 year CMS, whereas the Citibank Note only offers 4x.  Since HSBC and Citibank have similar credit ratings, this Note is arguably more attractive.  I, however, recommend avoiding this Note for the same reason that I told readers to avoid the Citibank Note – the spread between the 30 year and 5 year is too narrow and unpredictable historically to rely on it for the next 15 year period.   (I am more comfortable with the spread between the 30 year and the 2, as was offered by Chase, a better credit rating, in October.)  Those interested in this Note, however, can learn more about it by referencing CUSIP No. 40432XNT4 or ISIN No. US40432XNT45.

Societe Generale’s Structured Note is also based on another much used equation by investment banks these days.   Their offering, also 15 years, pays a fixed 7.75% APY, provided that the 6 month LIBOR rate stays between 0 and 5% and the S&P 500 does not fall by more than 25% from its value on the pricing date.  This Note, called a "hybrid" note because of the two separate contingencies, is similar Note issued by Chase in September (discussed here), but the comparison is not favorable.  While the Chase note only offered 7.50%, Chase has a much stronger credit rating. I also view the S&P knock-out provision in the Societe Generale Note as a real risk on a 15 year note, especially for a Note priced after a tremendous rally in the stock market. Those interested, however, can find this note under CUSIP No. 83368WGG0 or ISIN No. US83368WGG06.

As tempting as Structured Notes are, especially with interest rates looking likely to remain at low levels for a prolonged period, investors would be well advised to take a balanced approach and wait for those with the best terms and highest credit ratings (Chase and Goldman Sachs) and not to chase questionable offerings such as these from subsidiaries of European banks.