No Debt Plan

No Debt Plan is a blog about living a debt-free life. If you're new here, you may want to subscribe to my RSS feed (e-mail subscription also available). Learn more about me, or some of my most popular posts. Thanks for visiting!

(Image by No Debt Plan)

IndyMac failed last week and has the great honor of jumping to 2nd place in the coveted list of “largest bank failures in the United States… ever.” The massive investment bank Bear Sterns was bailed out by the Fed and JPMorgan earlier this year. Fannie Mae and Freddie Mac are being propped up by the government as I speak.

There is a feeling of panic on Wall Street. For account holders at IndyMac bank, Monday morning was also full of distress.

Is your money safe? What if your bank went under out of the blue? Could you pay your bills, fill your tanks with gas, and put food on the table?

What’s the FDIC?

FDIC stands for Federal Deposit Insurance Company. They insure that the money you have in your bank account — up to a certain point — is guaranteed to be yours. As in, you can’t lose it if the bank goes under.

A quick example: you have a checking account and a savings account at ABC Local Bank. The checking account currently has $6,000 in it; the savings $15,000. ABC wrote some seriously poor mortgages, over-leveraged its assets, and is now going under as a business.

You walk to the bank in town one morning to deposit a check your Mom sent you for your birthday. To your surprise, the doors are chained shut and a notice is on the window. That notice informs you the bank is going under and the FDIC is taking over.

Is all of my money safe?

For average Joe American I’ve got to nearly say “Yes!” to this question. However, technically there is a limit. For each bank you hold accounts at, your money is insured up to $100,000. So unless you’ve got more than $100,000 in total deposits at that bank, your money will come back to you.

As a side note, the FDIC likes to take over banks on Fridays. This gives them time to settle into the systems over the weekend and insure a smooth transition on Monday morning for those account holders trying to access and withdraw their money.

The FDIC only covers checking/savings accounts, right?

Wrong. The FDIC will also cover IRA accounts up to $250,000. This was a surprise to me as I had always heard the typical $100,000 insurance protection mentioned. So if you also opened up Roth IRA with ABC Local Bank, your account is “safe” up to $250,000. Hopefully in the future you will have more than that, but that would definitely cover me personally right now. (I wish it weren’t so!)

I’m curious as to how that works with the IRA accounts. Are you able to roll over the holdings to a different account, say, one with Vanguard? Or do you have to pull the money out and reinvest? I’m guessing the former because the latter could make for a messy tax situation.

The Bottom Line

If you have less than $100,000 in various checking/savings accounts with a bank, your money is insured 100% by the FDIC.

If you have less than $250,000 in Individual Retirement Accounts at a bank, your money is insured by the FDIC.

If you have more than $100,000/$250,000 in the above accounts — what are you thinking? Walk across the street, open a new savings account with XYZ Local Bank and give them any money over $100,000 from your savings.

Can you do this with IRAs? That is, can you have three different IRAs with three different institutions, each with $250,000 in them? How many IRAs can you have open at one time? I’ll answer these questions tomorrow.

On Monday I asked you which briefcase you would choose: a coin flip on $250,000 or some other guaranteed amount. I also asked what that guaranteed amount would have to be for you to not take the coin flip. So if the other briefcase contained $50,000 would you take the guaranteed $50,000 or still do the coin flip.

As you might imagine, there were a wide variety of answers. You aren’t all crazy, just some of you.

• Mike said it would have to contain $125,000 or more.
• Wide Open Wallet said $25,000.
• Jeremy said enough to cover his non-mortgage debts, although didn’t say how much that would be.
• Amphritrite said $200!
• Lynnea said $20,000.
• Stephanie said $10,000.
• Seb said $100,000.
• Eric said $10,000.
• On a forum I participate in, someone said $250,000!

As you can see, a wide range… $200 to $250,000.

This is a Risk Assessment Tool

As some of you have probably guessed, this is a risk assessment tool. The lower the amount of money you would accept to avoid the coin flip risk, the lower your risk tolerance. The more you will accept, the higher your risk tolerance.

The expected value of coin flip case is $125,000 - ($250,000 x 50%) + ($0 x 50%). If you have to have anything more than this in the case, you might enjoy risk. (In my opinion, you might enjoy it too much!) If you would accept $125,000 you would be considered risk neutral. I don’t believe anyone is truly risk neutral. If I opened up the case and showed you $120,000 I would bet 99% of the time that person would take the case. I know I would gladly give up $5,000 to guarantee $120,000.

Personally, my number is $10,000. That is a very healthy payday for no work. Don’t get me wrong, $125,000 for no work would be great, but landing on the wrong side of the coin would, in a word, suck. We wouldn’t retire off of ten grand, but it would help us move along toward that path.

Lessons Learned:

• Everyone has a risk tolerance. Learning and knowing this can help you understand previous decisions you’ve made as well as guide you in your future decision making.
• Risk tolerances vary greatly from one individual to the next. This can make communication difficult, especially in a relationship. If your spouse can accept a high level of risk and you can accept none, there may be a few bumps in the road ahead.
• Understanding the expected return or expected value of two different opportunities can help you make better decisions.

What would I do with $10,000? Fund the rest of our Roth IRA’s for the year, and add the extra to our emergency fund. Plain Jane, but still sticking to the plan.

(Photo: Little Case by Banalities.)

Riddle me this: imagine yourself enjoying a peaceful Saturday afternoon. You’re sitting on your back porch with your laptop, catching up on some articles at NoDebtPlan.net. As you contemplate how to invest your money — 401k or Roth 401k? — the doorbell chimes throughout the house. You meander to the door and find a stranger in a black suit waiting. It’s an older, wealthy looking gentleman holding two metal briefcases. He smiles.

“It’s your lucky day. In the briefcase in my left hand, I have $250,000. You can win that money, no questions asked, if you flip a coin and call heads or tails correctly before it lands.

However, in my right hand I hold another briefcase. You can take it without having to flip any coins. It holds $_________.

Which briefcase do you want?”

The real question I have for you today is, how much money does the second briefcase need to hold for you to take it over the first one? $1? $10,000? $249,999?

So, what’s your number? Leave a comment and we’ll revisit this post in a few days.