AskDong

I have posting even less than usually do. I’m currently in London on vacation. My brother is working here for the forseeable future and this was as good a time as any to visit him with the rest of my family. I carved out a few days in the beginning for some time on the “continent” with my girlfriend. We spent 3 days in Paris. As usual I will have some commentary on the economics of the trip once I get back. Hope everyone has a great New Year’s.

I got another letter last week from Barclay’s bank telling me they were closing down one of my credit card.  It’s the only credit card I have with that particular bank.  This is the second credit card company that has decided to the shut down my account.   Three weeks ago, it was Washington Mutual.  The credit card closing are widespread, or so it seems.  I only agree somewhat with the CNN article.  I think the credit card companies are only minimally motivated by the desire to reduce cost.  The bigger issue is risk.   These unused credit cards represent looming and potentially risky liabilities.   Credit card companies spend much money marketing balance transfer offers, and insurance protection.   The cost of maintaining a credit card that gets no mail pales in comparison.

In the end, I’m not all that upset some of my credit cards are getting canceled.  I have too many, and many of them serve no real purpose.  I don’t need the credit, and have been thinking about canceling some of the cards on my own.    The critical factor of course is not allow my oldest credit card to fall by the wayside.    Luckily my oldest credit card has a balance from a balance transfer offer that I will continue to payoff for the next few years.   There are other credit cards that you shouldn’t close or allowed to be closed.

I’ll be the first to admit I supported the federal bailout of the banks, the TARP.  I still support the bailout, but share with others concerns on oversight.   The money needs to be used wisely.  What has me aghast today however is the decision to pay hefty bonuses on the part Morgan Stanley and Goldman Sachs’ which reserved 10.9 billion for it’s bonus pool.  The total bonus pool has been cut 25-40% compared to last year.   To me that’s not enough.  I supported the bailout because I believed that the injection was necessary to keep the banks solvent, not to feed the fat cats.  If the banks are truly strapped as I believe them to be, it seems irresponsible to pay out such bonuses.   Banks to my knowledge are refusing to lend because they feel they are not capitalized enough.  If this is truly the case then all extra monies should be going to shore up the capital base.

At the same time I’m sympathetic to the position the banks are in.  There are a number of good reasons why the banks should be paying bonuses.

1. Many employees have had profitable years and have nothing to do with subprime.  Traders are acutely aware of the exact profit they make for the firm.  
2. Banks want to retain top employees.
3. Bankers are paid dispproptiantely via bonuses.  Anywhere between 1/2 and 99% of a banker’s compensation is derived from the year end bonus. 
4. Some banks did not want federal funds, but were forced to take them anyways. 

I believe in all the above to varying degrees.  Bonuses should be paid, but at fraction of the levels that are being handed out currently.   I cannot think of any other industry that would have the gall to require a federal bailout and then pay it’s employees hefty bonuses.  Up to this point I have not shared the public outrage towards the bank bailout.  I firmly believed that the bailout was necessary for the good of the global economy.  A strong banking system underpins a health economy. 

I’m not angry yet, but I have become a little irate.  Again, while I believe in all the reasons to pay bonuses, there are some solid counterpoints.

1. Yes, some employees did have a very profitable year. However, had the government allowed the bank to go insolvent, bonuses would not have been paid.  Bankers can’t always socialize the risk and privatize the profit.  
2. Given the job market, I have a hard time believing employee retention is as much of a problem RIGHT NOW as it has been in the past.  It’s not like hedge funds are having a banner year.  Some employees will leave, but I also believe that great companies succeed not purely by catering to people’s greed.  I may be naive but I believe great companies instill loyalty by doing the right thing.  The right thing now is scaling back bonuses, and compensating loyalty later when the the ship has been righted.
3. Bankers despite earning most of their compensation via bonuses still receive very healthy salaries.   Would it be the end of the day for banker making $150k a year to receive “only” a $50k bonus?
4. The last point is trickier as there are some banks who did not require federal assistance.  I doubt Goldman or Morgan Stanley to be such a bank.   Regardless given that these banks are paying out bonuses in excess of profits, it would give to reason that they might want to scale back. 

I have been living in this country for the last 7 years and I’m now ready to start investing. I don’t have clue where or how to start. I’m very risk adverse and I have all my $ on a saving account ( I know..it is no good). Can you give tips for real beginners? How to even think what % of your income should go to investing while you have your 6 month cash in case of a rainy day.

Thank you so much!

-Andrea

Great question.  Starting to invest is hard to to do, especially if you’re risk averse.  There’s no simple answer as how and what should invest depends very much on what you’re planning to do with the money.  A 25 year old who’s saving for summer house versus a 60 year old who’s putting the last few dollars toward retirement are going to want to do very different things.

I’m going to make a few assumptions:

• You’re relatively young (25-35?)
• Already have at least 6 months of an emergency fund

I don’t mean to be trite, but you should save as much as you can.  More importantly set goals for your savings.  Don’t save just to save.  Save for retirement, save for a house, save for charity.  It doesn’t matter what your saving for, but having number is important.  By setting a goal, you’ll not enjoy the process of saving more, but have a better idea how to manage your investments.

Given that it sounds like you’ve already managed to put money to savings, I would first max out your retirement accounts (401k, Roth IRA), and once that’s done funnel what extra savings you have towards brokerage or mutual fund account.  Another reader asked me a similar question a few months ago and I gave my rule of thumb how to prioritize investment accounts.  Since you’re starting, I would recommend opening an account with either Fidelity or Vanguard.   I opened a Vanguard account last year myself to take advantage of their low fee index funds.

Once you have an account open, it’s a question of picking funds.  The best place to start is with a total stock market index such the Total World Market Index, VTWSX. A fund like that gives you instant diversification.  After you get the hang of mutual fund investing, you can then start diversifying with other funds and making sure your asset allocation is good.  i.e. you have enough stocks versus bonds.

The one other issue I want to address is that your risk aversion.  Most people are risk adverse.  I’m risk adverse.   However, I do want to warn that often what seems like the safe choice is actually the riskier choice in the long run.   Remember your time horizon.   If you don’t need the money for 20 years, the volatility should not really be an issue.  This is not to say that I’m strict adherent to the buy and hold strategy as I think it’s a little foolish to just “buy and hold” without any concern to what’s happening in the world or your personal life.  Rather, I advise to make measured choices (or have a good adviser) and don’t be afraid to invest just because something can lose value.

I hope this helps.  However, in truth while starting to invest is easy, taking the time to do it properly takes some time.   I’m not even talking about picking stocks, but just getting a feel for where you want to go.

After reading this from one my favorite personal finance blogs, I hurried to check my account. Same Account, and same results. Like Jonathan, I have kept the Washington Mutual account because I find the credit scoring useful. The account is otherwise pretty much useless for me. I don’t earn any rewards, nor does the account have a great APR (not that I keep a balance). Given the comments on My Money Blog, and the cancellations amongst my friends, Wamu has clearly decided to cut off many of it’s “customers.”

Personally, I don’t blame them. Given the current credit environment, why would any credit card company want potentially risky line of credit out in the ether? Even though the accounts are unused, it still cost something to service these unused accounts. Washington Mutual has spent at least a few dollar, mailing me new cards. More importantly, these lines of credit represent potential risky liabilities. Why would someone start tapping a credit card they haven’t used in a year? The best reason would be because they’ve run out of credit on their other cards. If I were in desperate situation that’s certainly what I’d attempt to do to stay afloat.

The problem of course if someone is tapping every line of credit, that person is not a good financial risk. Washington Mutual doesn’t have the option later that such person is a bad credit after he or she has already charged $3000. What they can do now is to cut out all the tumors many of which are benign (like myself and Jonathan) instead of waiting and finding out which ones are actually malignant.

What’s happening to people personally is very similar to what’s happening in the corporate world with more dire consequences. Banks have withdrawn lines of credits, and many companies who depend heavily on the ability to borrow have found themselves in situations where they can’t. While I may personally be miffed that I don’t have a free credit score anymore, I didn’t need the line of the credit to expand business. Corporations are not so lucky.  The economic pain of credit tightening is here and very real.   We won’t even feel the full effects until many months later.