Is "Insured Savings" An Oxymoron?

In light of the market's recent decline, many investors — that is, the lucky ones who have some money left — have returned to tried-and-true passbook savings accounts that are insured by the Federal Deposit Insurance Corp. (FDIC). Frequently, passbook savings accounts are another form of the current negative savings rate. While it is true that in FDIC accounts, armed thieves, corrupt corporate cooks, bank embezzlers, and their ilk will not be able to steal your savings, the sad truth is these insured accounts are, for the most part, guaranteed to die a more lingering but equally complete death.

THE TREACHEROUS TWINS

FDIC-insured savings, especially the meager savings of the nonwealthy, are constantly being consumed by another set of treacherous twins. These twins are the state-sponsored savings swindlers known as Taxes (Tee) and Inflation (Eye). Working in concert, these two often extract more money from an insured passbook account than the account earns in interest. This is true even when US interest rates are two or three times higher than what is now generally available to the average saver. At present, most bank passbook savings are returning less than 0.6% per year. Though savings and loan institutions regularly pay about twice as much as banks, it still leaves the average interest for all passbook savings accounts well below 1%.

Right away, we can see that savers in the US are in extensive trouble with that rascal Eye. This is a major problem, even if you believe the government's rosy figures that Eye is only 1.8%. That's still about twice as much as what your passbook savings accounts are paying — over three times as much if those savings are in many ordinary banks! Why? I'll tell you later.

Though the nasty Tee takes a smaller bite than the insidious Eye, Tee is much more visible about it. While the Eye is pretty much invisible, every year on April 15, omnipresent Tee comes out and flaunts his ability to take part of your savings. Taxes — Tee — on small amounts of interest are not unlike salt being rubbed into wounds caused by trying to scrape by with inflation.

THE RAT RACE, IN THEORY

Let me put this in the most basic terms of the rat race of life. Rat A spends everything he makes. Every month, he gets 833.34 precisely measured bites of cheese. At the end of every month he has consumed every bite, and maybe taken out a loan for a couple of extra nibbles. Government and industry cheer Rat A's total contribution to the strength of the nation's economy, as fully two-thirds of that economy comes directly from consumers.

Rat B makes exactly the same salary as Rat A, but has an eye to the future. He wants to put away some savings for a rainy day, or perhaps for little Ratsby's college education. Every month he tucks away 83.34 bites, or 10%, in an FDIC passbook savings account. Rat B's FDIC-insured savings institution promises his account will have a small, but steady, return of 0.8% at the end of the year, in addition to all the cheese he entrusted to their care.

Both Rats A and B are your basic hard-running rats. They are the kind of rats that keep the race going. That said, the way the economy is now set up, there is a definite penalty paid by the vanishing breed of type B rats that wish to save.

This is how things turn out at the end of the year. Rat A has enjoyed to the max all 10,000 bites of his cheese, plus the extra from his loans. Rat B hasn't managed to live quite so high, but he has now put just over 1,000 bites in his FDIC-insured account. That savings, 10% of his income, plus the extra eight bites of earned interest, puts Rat B well on the road to becoming a wealthy rat according to Napoleon Hill's classic book on saving, Think And Grow Rich.

THE RAT RACE, IN REALITY

With apologies to Hill, that's not quite how it works in the US today. While the FDIC did guard the 1,000 saved bites from obvious thieves, they could not protect it from the demon Eye. Over the course of the year, Eye came in and quietly scraped enough off of each saved bite to remove an accumulated total of 18 complete bites. Sound bad? It gets worse.

The FDIC assures Rat B he now has 1,008 bites in the account. There is no mention each of these bites is somewhat smaller than they were originally. The inflation-trimmed bites actually make up only 982 of the full 1,000 bites that were originally saved, and the eight bites earned are similarly reduced. Basically, Rat B has crimped his lifestyle to save in an FDIC-insured safe place, increased his savings with interest, and now has less than he started out with. Rat B has a guaranteed loss of roughly 1%. His insured savings turned out to be an insured loss. And we haven't even mentioned the other twin, Tee.

The economy (government, corporate America, and so forth) just don't like rats who save. Saving falls directly into the "No good deed goes unpunished" classification. The IRS (ever notice that if you run those two words together, it spells "theirs"?) now sends in Tee. Tee takes one look at what the bank said it paid in interest to Rat B's account and announces, "I am going to have to tax you on your eight bites of return. That'll teach you to try and save!"

Complains Rat B, "But you already let Eye come in and take twice as much as I earned in my insured account!"

"Let that be a lesson," replies Tee. "We want you to spend, spend, spend! It's bad for our Gross Domestic Product when you save. Inflation is necessary to maintain a healthy economy!"

And so it is that savings come and savings go. Dotcoms have become dot-gones by the thousands. Individual investors have seen trillions of their retirement dollars go down the drain as a result of trusting corporate giants like Enron, Worldcom, and Global Crossing, or maybe even their full-service brokerage house or accounting/consulting firm. If somehow a small investor manages to achieve a tiny dividend, or a tiny return on their savings, it is taxed just like regular income. Is it any wonder that, as a country, our citizens' savings are between nil and negative?

A RIDE ON THE ROLLER-COASTER

The stock market and the dollar appear to be in downtrends not unlike a harrowing ride on a really big, really steep roller-coaster. A look at the financial horizon shows precious few sectors in apparent uptrends. However, two of those improving sectors are foreign currencies and gold. The reason is pretty obvious, as both of these sectors react more or less inverse to the strength of the dollar and, to a somewhat lesser extent, the markets in general.

Wouldn't it be nice if we could invest in the appreciating currencies of countries outside of the US and still have FDIC insurance? Would you believe we can? With as little as $2,500 savers can diversify into foreign currencies in an FDIC-insured account. Even better, with as little as $10,000, savers can purchase foreign currency certificates of deposit (CDs) with maturities up to one year. These CDs earn the often higher interest rates of the issuing countries in addition to their appreciation against the falling dollar, and they can do all of that in an FDIC-insured account.

Once again it is the old risk versus return thing, but this time there is a small advantage to the rats. Keep in mind that just as in the story of the rat race, the FDIC only protects your savings from the visible thieves — excluding Tee, who is always there to snatch his share. Still, as long as other world currencies go up while the US dollar continues to go down, an investment in those appreciating foreign currencies would go a long way toward counteracting the damage of the malicious Eye.

In that case, in an ironic twist, Eye would become an unwitting ally and help grow your savings. Both you and the opportunistic Tee would like that. However, the downside becomes apparent at once. If the dollar begins to gain strength against the currency you have chosen as your investment vehicle, you lose three ways instead of just two — the ever-present risk when you're looking for higher returns. Careful selection of the currency you choose as your investment vehicle should go a long way toward keeping that risk to an absolute minimum.

Now, if only the little and middle rats could just get a break against Tee! Let's say there are no taxes on the first $1,200 a year of interest and dividends. That would make saving and investing in US corporations something the rat masses could chew on. With all that money not being spent to raise the balance of payments, just think how much US money would be kept in the US. Such a savings and investing program might even knock down big Eye and slow the dollar's rush down the mountain. Alas, that solution would run contrary to the spend, spend, spend mentality declared necessary to grow the economy. There's no need to mention how infuriated that would make nasty Tee and his associates, besides which, whoever heard of small investors getting a big tax break on savings?

I hope this will get you thinking. Check out the links below for the broader picture.

Bruce R. Faber can reached at BFaber@Traders.com.

RELATED READING

· World Currency Accounts:
http://www.everbank.com/canvas.asp?id=1774&IdPage=pro_wc_aa_t2

· World Currency CDs:
http://www.everbank.com/canvas.asp?id=1732&IdPage=pro_wc_cd_t1

· Average Passbook Interest:
http://www.bankrate.com/brm/news/sav/20021021a.asp?prodtype=dep

· Loss of Purchasing Power:
http://www.bankrate.com/brm/news/bank/20030103a.asp

· Trillion Dollars of Passbook:
http://www.fool.com/money/banking/basics/purpose.htm

· Credit Bubble:
http://www.prudentbear.com/creditbubblebulletin.asp

· Chart of $ Index:
http://www.irs.gov/taxtopics/page/0,,id=16195,00.html

· Interest Rates:
http://www.bankrate.com/brm/rate/dep_home.asp

· The Bernanke Speech:
http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm

· The Alan Greenspan Speech, December 2002:
http://www.federalreserve.gov/boarddocs/speeches/2002/20021219/default.htm

· Best CD Rates in the US:
http://www.financialglossary.com/results.cfm?Alfa=E

Current and past articles from Working Money, The Investors' Magazine, can be found at Working-Money.com.