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Quietly wondering whether your money is safe at the bank?

spamurthy

Updated: Aug 3, 2023

You are not alone. I have received emails from clients wondering the same thing, and for good reason.


To date, American bank failures have exceeded the failures of 2008. <LINK> Silicon Valley, Signature and First Republic Banks have all failed in quick succession. However, unlike in that year, the financial markets have remained calm, even as the government has stepped in to protect depositors. But we could see more banks fail and you are probably wondering if you should do something about it.


Here is a simple explanation of different accounts and how safe they are from financial turmoil.


CHECKING, SAVING ACCOUNTS, CDs and MONEY MARKET DEPOSITS

These accounts are called demand deposits – money that the bank must return to you as soon as you demand it.


What happens: The bank takes this money and lends it out to others as loans, and profits from the interest received. The bank adds it to its own balance sheet.


What is the risk: Except for a small amount (the “fractional reserve”, the bank lends out your money as long-term loans like mortgages and business loans. This creates a mismatch in timing. If all depositors withdraw their money in short order, as they are allowed to, the bank is unable to find the money quickly.


How big is the risk: Your accounts are insured by the FDIC. Up to $250,000 – per depositor, per bank, per category. So, your individual account and a joint account get separate $250,000 policies.


Should you be worried: Not really. Our financial system is vastly different from the 1930s when the Great Depression led to many, many bank runs and depositors losing their money. Most of us have less than the insured amounts. Even so, the US government has now set a precedent that it will step up and protect even amounts higher than $250,000. If you are still nervous, I recommend opening up separate accounts at different banks as a way to manage this risk.


401K, IRA and OTHER BROKERAGE ACCOUNTS

These accounts are very different from your bank accounts and are generally much safer.


What happens to it: Unlike banks, custodians (Altruist and Schwab are the brokers I use for my clients) cannot use your funds to make loans with. The broker does not carry your stocks and bonds as its own assets, they simply house them. This means they cannot lend against your assets. Even the cash in your accounts is “swept” into money market investments and are not part of the broker’s assets.


What is the risk to it: The key risk to your stocks and bonds is that they will lose value – either due to economic conditions or company-specific outcomes. In other words, your 100 shares of ABC Inc. can lose 50% of their value, but there is little risk that you will lose ownership of the 100 shares.


How big is the risk: The risk isn’t zero, however. For example, there could be a failure to record your ownership of certain shares. The chance of this is very small. And for remote possibilities like that, your accounts are insured up to $500K each by SIPC (a cousin of FDIC, but materially different in its operations). Each account type (Roth IRA, IRA, Individual or Joint) is considered separately, and protected up to $500k each. Even the cash in your accounts is “swept” into money market investments and are not part of the broker’s assets.


Should you be worried: No. Just make sure your passwords are strong and safe.


ETFs and MUTUAL FUNDS

Owning an ETF or a mutual fund is like owning many stocks or bonds, but there is a new layer of risk introduced.


What happens: When you buy an ETF or invest in a mutual fund, you give your money to the fund manager in exchange for a share of the fund. They, in turn, buy stocks or bonds on your behalf.


What is the risk: the risk to these funds is like that to your brokerage account. The money is usually deposited with an independent company (called custodian), and fund managers cannot treat your money as their own.


How big is the risk: Very low. Even if Vanguard goes bankrupt, your shares in a Vanguard ETF are safe. Again, you still bear the risk to the value of your shares, but your ownership of those shares is secure.


Should you be worried: Not really unless you are invested in some highly leveraged or poorly managed funds.


In summary, your investments, like everything else, carry some risk. But the risk to your investments in stocks and bonds is different from the risk to your bank deposits. Today’s banking system is much better at protecting your cash assets.


However, the risk inherent to investments in securities – stocks, bonds etc. are bigger and more serious. And the best way to mitigate that risk is to have a sound financial plan that is in keeping with your investment horizon and diversify your investments.


This material is intended to be of general interest, not personal financial advice or a recommendation to buy, sell or hold any security or adopt a particular investment strategy. Your circumstances and attitudes toward risk matter, and only an advisor working with you can give you specific advice. All investments carry the risk of loss, including loss of principal. Stock and bond prices can be volatile. Past performance is not an indicator or guarantee of future results. Diversification does not guarantee profit or protect against risk of loss. This material may not be reproduced, distributed or published without prior written permission from Sanjay Pamurthy/Artham Advisors LLC. Data from third party sources quoted here has not independently verified, validated or audited. Although information has been obtained from sources that Artham believes to be reliable, no guarantee can be given as to its accuracy and such information may be incomplete or condensed and may be subject to change at any time without notice. Artham accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.

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