While the banking crisis seems to be contained, the long-term consequences are unknown. It could be a symptom of more trouble ahead.
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All eyes were on First Republic Bank this past week as it reported its first-quarter earnings. Investors were using it to gauge the current financial health of regional banks. Unfortunately, the news was worse than expected.
The regional lender that got swept up in March’s banking turmoil said its deposits plunged by more than 40% last quarter, losing $102 billion in deposits in that month alone. While bank executives hoped to express confidence that it has since stabilized, many investors were not convinced. The bank’s stock, down by as much as 97% this year, fell nearly 50% after the release of its earnings report. Early this week, news broke that JPMorgan Chase purchased First Republic. And now other regional banks are following a similar path. PacWest Bancorp and Western Alliance have seen their shares dip nearly 50% and 40% this week.
So, how can you as an investor protect your investments including your cash accounts against the turbulence and unpredictability of today’s market?
Turns out the banking crisis itself provides an answer. I’ll explain the one major lesson from it that can help you manage your portfolio and make you a better investor.
What Caused the Banking Crisis
Let’s start with the factors that caused Silicon Valley Bank to fail and sparked the banking crisis.
Silicon Valley Bank (SVB) primarily served tech startups and their investors. While the tech industry experienced major growth from 2019 to 2022, it invested most of its deposits in U.S. Treasuries and other long-term debts. At the time, these relatively low-risk assets were paying low-interest rates.
But when the Federal Reserve started raising rates aggressively last year to combat high inflation, startups started burning through cash and the value of the bank’s bonds declined. To cover increasing withdrawals, SVB was forced to sell off some of its government bonds at steep losses as yields on new bonds were much higher.
This led to a bank run by panicked depositors until federal regulators took control. Still, it triggered turmoil among regional banks, including the collapse of Signature Bank, and worries about the financial system spread across the Atlantic, leading to the sale of Credit Suisse to UBS Group.
The lesson here for individual investors: it’s dangerous to put all your financial eggs in one basket, especially when so much in the market and economy is in flux. Thankfully, there is an investment strategy to help you avoid that mistake in your portfolio.
Diversification Is Key
There is always the risk of losing money in the market. That risk is highest if you invest all your money in one investment.
Essentially, SVB failed at managing risk in its portfolio. You can control risk in your portfolio by investing in a mix of assets, such as stocks, bonds and real estate. This investment strategy is known as diversification—and diversification wins all battles.
The goal is to hold investments that don’t move in lockstep with each other. This can help mitigate risk and provide a more stable return on investment. By diversifying you won’t hit home runs, but you’ll avoid strikeouts.
While diversification appears to be a simple strategy, many people fail to put it into practice, as in the case of SVB. That’s often because people tend to chase only the hot-performing investments, which is typically a losing strategy. Consider research that shows that on average, the fewer stocks a fund owns, the lower its returns.
Most importantly, diversification takes the guesswork out of investing. You don’t have to try to pick the future winners or guess what the Federal Reserve is going to do next. Generally, the greater the variety of investments you own, the more protected you are from significant losses, but also the greater your chances for owning market winners.
That’s important right now as so many factors—high inflation, interest rates, tightening credit—make it harder than usual to determine where markets are going.
Preparing for What Could Come Next
While the banking crisis seems to be contained, the long-term consequences are unknown. It could be a symptom of more trouble ahead. As the Federal Reserve continues to raise rates and businesses invest less capital, there is a higher possibility that the economy could fall into a recession.
A recession presents a challenge to any investor, but especially those hoping to leave the workplace soon. That’s because a stock market downturn is a common feature of a recession.
A sound investment strategy in these times would be to focus on a diversified portfolio that includes defensive stocks and safe-haven assets. Defensive stocks are those that perform well in economic downturns, such as utilities, healthcare and consumer staples—industries that tend to profit even in a recession. Meanwhile, bonds and precious metals are typically less volatile during economic downturns than stocks.
For those nearing retirement or dreaming of an early retirement, it may be wise to shift your portfolio towards more conservative investments, such as bonds and fixed-income securities, to mitigate the risks associated with a potential recession. Also, you may want to make sure you own dividend-paying stocks, which pay out a portion of their profits to shareholders in the form of dividends. They provide a steady stream of income and can be a good option for investors who are nearing retirement.
Lastly, many people fail to make adjustments as market conditions change. You want to ensure that your portfolio is still aligned with your retirement goals.
And, if you feel worried about your portfolio, it might be a red flag that you’re taking too much risk. Consider getting a portfolio review from a fee-only fiduciary financial advisor who can help you choose an appropriate asset allocation that you’ll stick with during all market conditions, even when you don’t see what’s coming.
Pam Krueger is the founder and CEO of Wealthramp, an advisor-matching platform that connects consumers with vetted and qualified fee-only financial advisors. She is also the creator and co-host of the MoneyTrack investor education TV series seen on PBS and the popular Friends Talk Money podcast. If you’re ready to work with an advisor you can trust, visit www.wealthramp.com.