The large depositors at Cypriot banks are shouldering a heavy burden. You'll recall what happened back in March when the Eurozone financial wizards forced average citizens to participate in what was called a "bail-in." It seems downright unfair for depositors with more than 100,000 euros to suffer a levy on up to 60% of their deposits. That's about $140,000, give or take, at current exchange rates. And if you're a retiree, having the government swipe $84,000 from your $140,000 account just to bail out feckless bankers is a pretty big deal.
The dangers inherent in the Cypriot crisis may seem foreign to us, but US bank and brokerage accounts are not as safe as we might think. The federal government may imply that we are preferred customers of the FDIC and the SIPC, but that does not mean we will get the royal treatment should our bank or brokerage firm go belly-up.
Years ago Braniff International Airways, which had a large hub in Dallas, was on the verge of bankruptcy. In an effort to support one of their own, many local businesses booked flights and paid for airfares in advance. But ultimately, the airline did file for bankruptcy, and they shut down operations. One of my clients at the time complained that everyone who had paid for their airfare in advance was considered a general creditor in the bankruptcy proceeding. After the IRS and preferred creditors received their due, the general creditors got pennies on the dollar.
Whether it's an airline, bank, or brokerage firm, when a company goes under, its customers quickly morph into creditors. It is one thing to lose a couple hundred dollars on a flight when an airline bellies-up. But it's a much more frightening story when our life savings is in jeopardy. The Madoff and MF Global debacles certainly made that point clear.
While we may think of ourselves as customers of our bank and brokerage firms, our money is at risk if they fail. Although the FDIC steps in quickly when a bank fails, there are limits to its coverage for individual depositors. Meanwhile, when a brokerage fails, the SIPC operates at a snail's pace. MF Global filed for bankruptcy in late 2011, and some of those claims have still not been settled.
Most of us know the FDIC limit by heart, but how many of us stop to think about the limits of SIPC insurance on our brokerage accounts?
According to the results of an Employee Benefit Research Institute study published in the Wall Street Journal, only 3% of workers retiring from the private sector have a defined benefit program. Unless you work for the government, there is a good chance you will retire with a 401(k), IRA, lump-sum payout, or some combination thereof. When I found myself in that very situation many years ago, the first thing I did was consolidate my retirement portfolio with a single brokerage firm. I had finally mastered its online trading platform, and it just seemed easier to have everything in one place. But at the time, I sure didn't stop to think about the SIPC insurance limits and the potentially disastrous effect on my nest egg should my brokerage firm have failed.
Do we really want the bulk of our life savings sitting with one company? What if they go belly-up? Can we afford to have a major portion of our nest egg tied up for months while the SIPC tries to sort things out? We may take comfort in knowing that our government insures our accounts, but it is foolhardy to take unnecessary risks. There are ways to protect our money, like diversifying across banks and brokerage houses, and wise investors do just that.
Diversification means protection. What if the government decides to change the rules in the blink of an eye and confiscate some of our money? It could happen, although I'm sure they'd use a more euphemistic word than "confiscate" - like "tax" or "fair share." Some politicians grumble that folks who invest offshore are not patriotic. Whether that's true or not, it may just be simple, prudent self-protection. Investors in Cypriot banks received little warning. We still have time.
Not long after starting Money Forever we decided that part of our mission was not only to help my peers with their retirement investing, but also to share new ideas for protecting our money. Many of us got clobbered in 2008 and watching events unfold over the past couple of years in places like Iceland, Greece, and Cyprus should give any saver pause about putting all of his or her money with one bank.
I have to admit that before I started this journey, having any of my money overseas was the last thing on my mind. Now, I'll be the first to tell you that I'm not some jet-setting world traveler dipping my toes in this and that country. I don't have accounts spread all over the place, but I can tell that I sleep more soundly at night knowing that not all of my portfolio is tied up in US "too big to fail" banks.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.