What Does Cyprus Teach Us? Diversify

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Diversify, diversify, diversify. This woman lost $200,000. This guy lost $1,000,000. Why? Because the evil bankers stole their money to fund a bank bail out because the banks were over invested in Greek bonds? Well…yes…

…but it's more than that. They lost this money because they didn't diversify or respect the insured deposit limit. The insured deposit limit is $250,000 per bank per person in the US and 100,000 Euros in the European Union.

It happens time and time again. People find a “sure thing” and dump their entire life savings into it. Enron. Bernie Madoff. Greek bonds and Cypriot banks. And yet time and again these sure things fail. And then it's the small time investors and depositors who are left holding the bag. Don't become a victim! Protect yourself by diversifying your savings and investments!

How to Protect Yourself from the Next Cyprus

A security guard watches over trucks delivering billions of Euros to Cypriot banks.

The Cyprus situation is not a pretty one. In the original plan every depositor in Cypriot banks was going to lose between 6-10% of the assets in their accounts. Today, the plan is that every deposit will get to keep up to the insured limit in their account, but 60-100% over 100,000 euros will be confiscated. This is of course an extraordinary situation. Could it happen in the United States?

Probably not. Since 2000, dozens of banks have failed in the US. In all cases, any of the accounts that were FDIC insured received full payment for their lost funds. In 2008, in the midst of the financial crisis, the FDIC raised the insured amount on all FDIC products to $250,000 from $100,000.

So what does that mean for you? At any financial institution, you are covered up to $250,000 per ownership category. For instance, if you had a savings and checking account in your name only, and you also had a checking account that you shared with your wife, you would be covered up to $250,000 on the accounts in your name and $250,000 on the joint accounts for a total of $500,000 of coverage at that institution.

Therefore, if you ever have more than $250,000 in anyone bank, ensure that you are dividing it between joint and single ownership accounts! Just to make it easier, never hold more than $250,000 at any one financial institution. If you have more than that in cash, you probably need to talk to a financial adviser anyways about putting your money into more productive investments.

There's an old saying about putting all of your eggs in one basket. If you have more than $250k in a single US bank, you are risking some of your eggs. Open up a new account at another bank. Spread your money around and don't concentrate it.

How to Diversify

Diversification is one of the most preached tenants of good personal finance and investing. How can you achieve diversification without over complicating your financial life?

  1. Never have more than $250,000 cash at one bank
  2. Keep a healthy stock-bond mix in your retirement and investment accounts. Using the Lifecycle Funds in the TSP is an easy way to do this. You can also use Target Date funds from Vanguard. A good rule of thumb is 120 minus your age and put that number in stocks, the rest in bonds. If you're 25 years old, 120-25=95% invested in stocks, 5% in bonds. You can do this until you hit 45, at which point you should have 75% stock, 25% bonds, which is the assumption of the Financial Independence, Retire Early Calculator.
  3. Never have more than 10% of your liquid net worth invested in any one stock, bond, or Lending Club note
  4. Use ETFs, mutual funds, and the TSP to purchase many companies' stock rather than just one or ten. With Vanguard Total Stock Market Index ETF (VTI) you can invest in over 3000 US companies, with a single $80 investment.
  5. Don't over invest in your house! Your mortgage payments should never more more than 25-30% of your total, before tax income (this means adding your BAH, BAS, and base pay for you military types. Don't go spending all of your BAH!)

I can't say it enough. Diversification is key to achieving your financial goals. DO NOT just invest in one stock. DO NOT put all of your money into Lending Club. DO NOT have more than $250,000 in any single bank. If you do all of this, you should be well on your way to achieving financial independence or whatever your financial goals may be.

Any other ways you can think of to avoid the next Cyprus?

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