Bank account risk is a topical subject today in the light of the failure of SVB Bank and other banks recently.
When it comes to managing your money, one of the most common options people consider is investing in a bank account. While it may seem like a safe and reliable option, there are risks associated with this type of investment that you need to be aware of. In this blog post, I will explore the risks of investing in a bank account and provide some tips on how to mitigate them.
The risks of investing in a bank account:
1.”Inflation is taxation without legislation.” Milton Friedman.
One of the biggest risks associated with investing in a bank account is inflation. Over time, the value of your money can erode due to inflation, which can have a significant impact on your purchasing power. For example, if inflation is at 10% per year and your bank account is earning a 3% interest rate, you’re effectively losing 7% of your money’s value each year.
Interest rate risk
2.”The only thing that is certain about interest rates is that they will change.” Alan Greenspan.
Interest rates are not fixed and can fluctuate based on a variety of factors such as market conditions, inflation, and the actions of the Bank of England. If interest rates drop, the amount of interest you earn on your bank account will also decrease which can result in a lower return on your investment.
3.”The four most dangerous words in investing are: this time it’s different.” Sir John Templeton.
Investing in a bank account is generally considered to be a safe and liquid investment but there are still some risks associated with liquidity. If you need to access your money quickly, you may find that you are unable to withdraw it from your bank account without facing penalties or fees. Additionally, if the bank experiences financial trouble, your funds may be frozen or inaccessible for a period of time.
4.”The price of a commodity will never go to zero. When you invest in commodities futures, you’re not buying a piece of paper that says you own an intangible piece of company that can go bankrupt.” Jim Rogers.
Investing in a bank account also carries a certain level of credit risk. This means that there is a chance that the bank may fail or become insolvent, which could result in a loss of your investment. While the Financial Services Compensation Scheme, FSCS, provides protection of up to £85,000 per account per banking group, it’s important to understand that this protection only covers deposits up to £85,000.
Mitigating the risks
While investing in a bank account carries some risks, there are steps you can take to mitigate them. Here are a few tips to help you protect your investment:
Diversify your investments
1.”Don’t put all your eggs in one basket.” Warren Buffet.
Diversification is a key strategy for mitigating risk in any investment portfolio. By spreading your money across different asset classes, you can reduce the impact of any one investment on your overall portfolio. This means that if one investment performs poorly, you have others that may help offset those losses.
Monitor interest rates
2.”Knowledge is power.” Sir Francis Bacon.
Keep an eye on interest rates and be prepared to adjust your investment strategy accordingly. If interest rates are expected to drop, consider moving your money into a higher-yield account or another investment that may offer a better return.
Research the bank
3.”Trust but verify.” Ronald Reagan.
Before investing in a bank account, do your research and make sure the bank is financially stable and has a good reputation. Look for ratings from independent agencies like Moody’s or S&P and read reviews from other customers to get a sense of the bank’s customer service and overall reliability.
The truth is that the banking system is very fragile because banks keep very little in reserves. This blog by Terry Smith summarises the risk of investing in bank shares very well.
Banks are run using the fractional reserve banking system. Again the fragility of banks is explained comprehensively in this article.
The plight of the US banks SVB Bank and Signal Bank who both recently failed highlights the bank account risk. These two failures are two of the three worst failures in the history of banking. The 166 years old Swiss bank Credit Suisse also failed but it was taken over by its Swiss rival bank UBS.
Interestingly there have been many more banking failures historically than retail fund managers which has lost investors far more money. In the 60+ years history of the Investment Association, no collective investment scheme (OEICS and unit trusts) has failed and lost an investor money. This includes Barings Fund Managers. When Barings Bank failed the depositors lost all of their money above the then compensation limit of £20,000 whereas the investors in Barings Fund Managers’ unit trusts and OEICs didn’t lose a penny. This was in the days when the FSCS did not cover bank deposits. The reason they didn’t lose any money was because investors’ funds were registered in the name of a large bank as custodian which gave them full protection when Barings collapsed.
Read some of my previous blogs on the subject of investment risk to increase your knowledge.
Think your money is safe invested in a bank account? Think again. If you have a long-term time horizon of at least 10 years, then invest most of your money in shares or in equity funds (funds that invest in shares) because there are many sources of research that show you will achieve higher returns from investing in equities than in the other main asset classes of bonds, property and cash (bank accounts). The quid pro quo is that you will have to accept a higher level of volatility with shares. Shares have historically been a terrific hedge against inflation too which is at a particularly high level currently. Just ensure you spread your risk by diversifying your holdings, be they in shares or in funds. You know it makes sense.*
The value of investments can fall as well as rise. You may not get back what you invest. The information contained within this blog is for guidance only and does not constitute advice which should be sought before taking any action or inaction. All information is based on our current understanding of taxation, legislation, regulations and case law in the current tax year. Any levels and bases of relief from taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future. This blog is based on my own observations and opinions.