© Andreas Prott | AdobeStock
Key Points:
- Insuring your cash by maximizing FDIC protection
- Why liquidity matters
- Staying in your swim lane – the critical role of Investor DNA
You’ve already heard about the recent failures of Silicon Valley Bank (SVB) and Signature Bank (SB) last week — the 2nd and 3rd largest bank failures in U.S. history.
News like this can be unsettling and it has certainly rattled the business and financial worlds.
But there are also some great lessons to be learned for us as individuals. Specifically, you can learn how to safeguard, access, and grow your wealth, especially during times of economic uncertainty.
Let’s take a look at each of these lessons individually.
Lesson #1: The importance of transferring risk through insurance (+ FDIC overview)
At Wealth Factory, we show our customers how to transfer risk in case of unforeseen events or catastrophes by optimizing all their insurance coverages.
And part of that optimization is having enough coverage. For example, if your home is worth $500,000, it makes sense to insure it for at least $500k (or more), right? Anything less means you may not get all your money back in case of a fire or other disaster.
How does that tie into the recent banking failures? Well, you may be wondering what would happen to your money if your bank were to fail. And it’s definitely something to think about. After all, in 2008-2009, over 430 local and regional banks ended up failing in the domino-effect aftermath of the Lehman Brothers collapse.
Banks fail when people don’t trust them to give their money back. If there are rumors that a bank may have overextended itself (often in bad decisions) and enough people ask for their money back — and the bank doesn’t have it — the bank fails.
This is where the Federal Deposit Insurance Corporation (FDIC) comes in.
The FDIC is an independent U.S. government agency that provides insurance to depositors in the event that their bank fails. The FDIC insures deposits up to $250,000 per depositor, per account ownership category.
Now it’s true that in last week’s events, The federal government stepped in and said they would make 100% of everyone’s deposits at SVB whole. That was either generous or foolish, depending on your point of view.
But the fact is, the FDIC has rules, and you should plan on the insurance for your money to only be what they promise. That means if you have more than $250,000 that you want to store in a bank account, you will want to use some risk mitigation strategies. That is primarily done by having multiple accounts and using more than one bank.
The FDIC system protects all types of deposit accounts, including checking, savings, money market, and certificates of deposit (CDs). So spreading your money among these different types of accounts can also give you broader protection and allow you to earn more interest along the way (although that should never be your primary concern with liquid accounts).
Even if you have less that $250K, it can be a good strategy to spread your cash out among different banks and different accounts. That way, if one bank fails, you may still be able to access your cash in another bank while the FDIC red tape sorts things out.
There are financial technology companies that can do this for you automatically. For example, Mercury Vault protects all your cash with a money market fund and up to $5M in FDIC insurance through their partner banks and sweep networks including Goldman Sachs and Capital One.
It is important to note that the FDIC does not insure investments, such as stocks, bonds, mutual funds, or annuities — even if you buy then through your bank. Also, the FDIC does not cover losses due to fraud or theft. So if you get scammed or phished, don’t expect any help from them.
Lesson #2: Liquidity is more important than most people realize
When we talk about liquidity, we are talking about money that can be easily accessed (or converted to cash quickly) without penalty. Immediate access is best, but as long as it can be accessed within 2-3 days, you can consider it liquid.
There’s one caveat here. We’re talking about liquidity to get your principal out. For example, stocks can be very liquid, meaning you can generally convert them to cash by selling them with the click of a button on your computer screen. However, that has some potentially unforeseen repercussions. If you have a gain on that stock, you are now liable for Capital Gains tax. And if you have a loss, you are pulling out less than you put in.
This is where the SVB debacle teaches a lesson. Silicon Valley Bank was “flush” with cash on its balance sheet. But they had been aggressively buying U.S. Treasuries over the last few years. And not short-term treasuries. They had 10 and 20-year notes on their books. The reason is clear. The yield on those long-term notes were higher than other yields at the time of purchase.
This would not have been a problem as long as they could have held those notes until maturity, because then the etire principal would have been returned.
The problem is, those Treasury notes lost 15%-20% of their value over the last couple of years as interest rates have been rising. So when there was a run on SVB deposits last week, they didn’t have enough liquidity to satisfy that demand — and they had to start selling off their Treasuries.
And the only way they could liquidate them was to sell them at a loss. It quickly became clear that if they had liquidated their entire portfolio of Treasuries, they would have been $2B-$3B short in their ability to pay back depositors. That’s insolvency, and that’s when the FDIC stepped in and took over.
The lesson for individuals is similar. It is understandable to want to chase high yields in investments, especially in times of low-interest rates. However, it is important to remember that higher yields often come with higher risks. Investing in assets that can fluctuate in price, such as stocks or bonds, may provide higher returns at some point. But they may prevent you from accessing your cash without taking a loss.
In times of economic chaos, liquidity is much more important than yield. Plus, it gives you opportunities to jump on opportunities like buying distressed assets or new investments.
The good news is that right now, you can park your cash in savings accounts, fully insured by FDIC, and earn between 3%-5% while maintaining full liquidity.
Another way to maintain liquidity without any loss of principal is to look into Cash Flow Banking. It doesn’t give you FDIC protection, but it has a bunch of other benefits that can be even better for building wealth tax-free.
Lesson #3: The importance of staying in your “swim lane” (Investor DNA)
The final lesson to learn from the recent bank failures is the importance of staying in your “swim lane” when parking cash — and learning to tap into your unique Investor DNA.
Silicon Valley Bank’s situation is a prime example of what can happen when a bank gets out of its swim lane. As mentioned, the bank had plenty of cash on hand, but a significant portion of it was invested in Treasury Bonds. When interest rates rose, the price of these bonds dropped, and the bank was forced to sell them at a loss to meet customers’ demands for cash during the bank run that happened.
While it’s not unusual for banks to have some of their reserves in Treasury notes and bonds, banks have a unique position and purpose in the financial ecosystem to create loans. This provides regular cash flow for operations, with an asset-based backstop. If the bank becomes strapped for cash, they can borrow against those loans, or even sell them to other investors. This is their strength and their “investor DNA” as an industry.
By investing primarily bonds, SVB strayed from their core competency, which ended up being disastrous. They didn’t have key people in a position to hedge against the risks of the bond market. And since they were outside their swim lane, they weren’t able to see the disaster before it happened (or they did and covered it up, but that’s a story for another day).
As an individual, it is essential to stay in your swim lane by recognizing your Investor DNA and investing accordingly. If you don’t know how to see problems ahead for the investments you’re in — or if you don’t know how to hedge against potential problems or volatility — then you’re not investing within your Investor DNA.
As we like to say, risk is primarily in the investor, not the investment. So figuring out your Investor DNA — and then staying in that swim lane — is the quickest and most effective way to minimize risk and safeguard your wealth.
Wrapping it up
The recent failures of Silicon Valley Bank and Signature Bank highlight the importance of understanding the FDIC system and maximizing the protection of any cash you have in the banking system.
It also highlights the critical roles that liquidity and Investor DNA play in preserving and growing your wealth, even in times of economic trouble or systemic bank failures.
If you’d like to learn more about how to protect and grow your money so you can reach Economic Independence faster, you may be interested in our popular Economic Independence Starter Pack. It includes info on maximizing your insurance coverages, creating cash flow and liquidity, and growing your wealth through Investor DNA.
