Money Angles

By Andrew Tobias

Citibank has been taking full-page ads for what it calls its Stock Index Insured Account. "With this unique account," runs the ad, "your IRA or Keogh deposit actually earns two times the average percentage increase in the Standard & Poor's 500 Index over a five year term. Yet it's 100% safe."

Double the S&P with no risk?

"I've only been in this business 25 years," confessed the president of a large brokerage firm, "but I can't for the life of me figure out how Citi can be offering people double the S&P."

Of course, there's a catch. No way could Citibank actually offer you double the stock-market return with no risk, though its ad and brochure make every attempt to convey that impression. But it's entirely legal, fiendishly clever (in a friendly, relatively harmless sort of way) and just one of the many things to be wary of as we desperately reach for alternatives to the 2.5% they're offering down at the local money-market fund.

Close reading of the Citibank ad tells the tale. But if my friend the Wall Street mogul didn't get it, how many widows and orphans will?

First, it turns out, you get none of the dividends the S&P 500 stocks pay over those five years; Citi keeps them. From 1961 to 1992, the S&P 500 has grown at 10.2% a year -- but only 6% a year if you exclude dividends. Second, Citi doesn't double the five-year gain in the S&P, if there is one. It looks at the average of the S&P over those five years, compares that average with the S&P when you started, and doubles that gain. Well, if a tree grows to be 5 ft. tall in five years, it's grown 5 ft. -- but its average height over those five years was only 2 1/2 ft. So doubling it ain't such great shakes after all.

But it's worse than that, because while trees only grow, the stock market sometimes shrinks. (Many of you are too young to believe this, but it's true.) What makes this deal work so well for Citi is that the downs reduce the average of the ups. Say the S&P, which is today near its all-time high, drops 25% over the next year, then just bounces around aimlessly until the fifth year, when it explodes, gaining back that 25% loss plus an additional, mouth- watering 50%. (These things happen too.) Had someone just bought the S&P 500 and held it for five years -- someone like Citibank -- he'd have got that mouth-watering 50% appreciation plus five years' dividends. Not bad. But had someone rolled his IRA over into Citi's Stock Index Insured Account, he would have got . . . zero. (In calculating the average, the first 48 bad months would have more than canceled out the final 12 great months.) His principal would be safe, but it wouldn't have earned a dime.

Naturally, this is not the example Citibank uses in its ad.

The most obvious risk to Citi is that, five years from now, the S&P will be lower than it is today, and Citi will have to make up the difference. But because the market's natural bias is up, what with growth and inflation, it rarely falls over any five-year stretch.

The less obvious risk is that the S&P might zoom 75% right off the bat, say, and then just sit there for five years. That would be an "average" 75% gain, which Citi would have to double. Wow. But, my friends, the chances of the market zooming 75% anytime soon are . . . Well, forget about it. In any event, Citi can hedge against these risks.

And consider: five years from now, on the off-chance Citibank has been forced to pay out more than the actual S&P gain, investors will be thrilled. Asked whether they want to renew for another five years, most will say yes. So, just as at Las Vegas, if Citi can keep the people betting long enough, it'll do just fine.

What makes Citibank's offer particularly loony for most retirement-account investors is that their retirement money is in the market for the long run. Why give up all the dividends just to protect against the possibility that the market could be lower exactly five years from now? Sure it could be. But over the long pull, unless you're in your 60s or 70s, what difference does that make?

Nor is Citi's offering the only thing to watch out for these days. Here's a small sampling:

WRAP ACCOUNTS. By far the most popular pitfalls are the "wrap" accounts most brokerage firms now offer. Tens of billions of dollars have flowed into them recently. They come in a variety of shapes and sizes, but basically they say: Look, you're an amateur. We're pros. Why should you worry your little head trying to manage your investments? For just 3% a year, we'll take care of < that for you! And we won't nickel-and-dime you on commissions: we'll wrap all commissions into that one 3% annual fee.

The only problem: 3% may not sound like much, but it's huge -- about a third of the 9% annual return one might expect from the stock market over a typical decade, an even higher share of the return you might expect from bonds. (Some brokers even apply the 3% charge to money held out on the side lines in money- market funds.) Worse still, all the income from a wrap account is taxable, but in most cases only a portion of the wrap fee will be deductible. So you could actually lose money, after taxes, by breaking even.

Ah, but the brokers offering these accounts are so much smarter than average, they will earn back that 3% in spades! Well, no, they won't. Not all professional money managers are above-average. In fact, taken all together, they pretty much are the average. So on average they will do about average for you -- minus this whopping 3%.

You're better off deciding what portion of your money you really intend for the long term, and then investing it yourself in two or three no-load mutual funds, or even just an S&P index fund. You, too, will do about average each year, and save most of that 3%.

MUTUAL FUNDS. The problem with throwing money into stock-market mutual funds -- everybody's doing it -- is just that: everybody's doing it. Maybe buying into the market at an all-time high will become the new way to get rich. But something tells me that even without the 3% wrap fee, people who've never invested in the market before shouldn't start now, at least not in any big way. But if you do start now, remember two things: 1) you can get professional management and diversification through mutual funds; 2) buy no-load funds, the ones that charge no sales fee (whether up front or in hidden "12b-1" fees). They do just as well, on average, as the funds that do charge sales fees.

LONG-TERM BONDS AND BOND FUNDS. There is certainly the temptation to grab 6.75% from a 30-year Treasury bond (free of state and local income taxes) rather than settle for a fully taxable 2.5% six-month CD. And this may be smart. Interest rates may continue to fall. (They're still higher than they were from 1880 to 1965.) But if rates should rise, your bonds will drop in value. You'll be locked into a 6.75% return when all around you are getting 8% or 9% or possibly even more.

So where should you invest these days? I'd keep a fair chunk of my money liquid, even if it means sitting with "cash" for a year or two. The time to buy things is when nobody wants them -- and right now, everyone seems to want stocks and bonds. If you're a small investor without a lot of time or expertise to explore the exotic, or the money to buy shopping centers from the Resolution Trust Corporation, now may be one of those times when the smart thing to do with a substantial portion of your funds is: nothing much.

Well, at least keep enough money in the bank to avoid bouncing checks, because I have one more thing to suggest you watch out for:

BANK FEES. Your bank's credit-card interest rates may finally be coming down (especially if you ask) but that just adds pressure to the hunt for other ways to charge you. The American Bankers Association recently held a "National Fee Producing Conference" to share some ideas, banker to banker. One attendee, reports American Banker, explained how he's changed his check-clearing policy so that when several checks come in on an account the same day, he now handles the largest first and works down. That way, he boasted, "if someone has $200 in the account and writes checks for $5, $10 and for $300, all three then become overdrafts and we earn $22 apiece." His small bank expects to earn an extra $80,000 this year from that one change alone.

Beware, beware, beware.