So Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

Regular AAC (Asset Allocation Composite), SAA and TAA portfolios are always rebalanced on the first trading day of a month. the next re-balance will be on Monday April 3, 2023. 

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Bank On My Own For Safer And Much Higher Returns

Well this finally happened: the second largest retail bank failure in the US history just happened in this weekend. Silicon Valley Bank (SVB), the most well known and popular bank for thousands of tech startups and companies in Silicon Valley was shut down by the government. Fortunately, depositors managed to get their cash back because the FDIC, the US Treasury department and the Federal Reserve bank worked together to come up with measures to back stop these depositors’ cash in order to avoid a more wide spread bank run in the nation.

The SVB failure is an excellent live learning material. In this newsletter, we will discuss a few important details.

How did SVB (and a bank) fail?

In a nut shell,  SVB failed because it had a bank run and it didn’t have enough liquidity to meet the redemption demand. A bank run is a sudden event when many depositors in a bank simultaneously withdraw money from it.

A simplistic description of a bank business is that it takes your (depositors) cash and then it lends out most of them (as mortgage, Treasury bills and bonds, loans to businesses etc.) and it only has a few percent of cash reserved for daily redemption and other needs. A bank makes money from the spread (the difference) between the interests it gets from lending and the interests it pays to its depositors.

In theory, even the most cash rich bank (in the US, currently, the largest best equipped one would be JPMorgan Chase bank) would have trouble to satisfy redemption demand if majority of its customers start to withdraw money as it’s almost impossible to get the enough cash back from a bank’s loans to return to its customers. However, in a realistic and practical case, not all of a bank’s customers are running to the bank to demand their money back at the same time. A cash reserve rich bank can deal with a bank run much better than a cash reserve poor bank. Furthermore (and actually the most important), it’s the customers’ trust in a bank that mostly prevent a simultaneous panic from happening.

In SVB case, its customers (most are tech startups) had started to withdraw their money because it was getting harder for them to raise extra capital and/or people became aware of SVB’s poor capital structure (see, for example, this tweet dated back in January). Here is some estimate by someone who did a study on several banks (see this). Note: we have not independently verified the data. This is for the purpose of the following discussion:

JPM: JPMorgan. BAC: Bank of America. WFC: Wells Fargo. SIVB: Silicon Valley Bank

The key to notice in the above is that SIVB (or SVB) had $91B invested in so called HTM (Held To Maturity) securities. The bulk of their HTM securities was 10 year US Treasury notes they invested in 2021 and they had yield 1.9%. SVB has about $173B deposits. They were forced to sell some other loans (more precisely available to sell securities or bonds) last week to meet the redemption demand that resulted in billions of loss and were forced to raise additional capital. This started to get people’s attention and thus the bank run began.

Notice also in the above, if SVB was forced to liquidate its $91B HTM Treasury notes, it would result in $15B loss that’ll be more than its common equity ($12).

Why did SVB buy so much $91B (out of its $173B deposit) long term 10 year US Treasury notes in 2021? The simple answer: they wanted to make more money. Since they were giving out almost 0% interest to depositors and at that time, short term Treasury bills or bonds were also paying extremely low interests, they ventured into longer maturity bonds that had higher yields (1.9% on average) in order to make more money.

In the above, we also see that BAC (Bank of America) would have incurred huge loss ($109B) if it was forced to sell its HTM to meet a bank run style of redemption demand.

In this case, even though US Treasury notes are considered to be default free, since their maturity dates are long time from now, their prices become much less today as interest rates are now about 4%, compared with 2% or so before (like in 2021). So if you are forced to sell these securities, you will incur large loss. But if you can hold them for 10 years to their maturity dates, you are guaranteed to get back both your principal and interest payments. This is the so called interest rate risk, one of the two major risks for bond investments. The other one is credit risk — whether a borrower can honor interest and principal payments. US treasury securities (long term or short) are considered to be virtually credit risk free as people always trust the US government to honor its debts (or at least among all of governments in the world).

SVB could have managed its capital much more conservatively by simply investing into short term (like 3 month) Treasury bills. Say if they had $91B instead in Treasury bills, even if there is a huge demand of redemption, they can easily sell these highly liquid bills in open market and in the worst case, incurring a very small loss.

To summarize: in order to make more money, banks took big risk to invest in risky loans (might in credit risk such as low quality mortgage loans or junk corporate bonds or interest risk, as in the SVB case). In the meantime, customers are getting paid much less (sub zero interests). It’s really a bad deal for a bank customer: you might risk your money while just being paying little in the meantime. It’s also a very good deal for bank management (bankers): they are getting hefty pay while in the meantime might be able to gamble other people’s (your) money. If the gamble fails, so be it. They’ll forgo bonus and even the job but can move on to other jobs. If the gamble pays off, their earnings and thus stock prices will be high, reaping more payout. In a word, the existing banking system is ill structured and asymmetric: highly favoring banks instead of its customers.

We now know why banks (and brokerages) don’t want to pay high interests

The SVB case also gives a big hint on why banks have been reluctant to increase their savings and checking interest rates even though Treasury bills’ interest is now yielding 4% and up. This is because when interest rates were very low, they became greedy and had big chunk of their capital tied up to longer maturity bonds. Since these long maturity bonds yielded much less (in SVB case, 1.9% in 2021) than today’s short term interest rate (4+%), if they were to raise payment to their customers, they will have much less profit or even incur some sizable loss. So they are stuck to the ultra low (sub zero) interests to customers even if they are willing to change.

Back in 2018, we started to alert our subscribers on the virtue of Treasury Bills and Brokerage CDs (see, for example, March 19, 2018: Treasury Bills vs. Brokered CDs) as banks had been paying pennies to their customers for a decade. In a low interest rate environment, it’s understandable. But in today’s environment where short term interest rates are now 4% or more, it’s absolutely hard to believe people are still satisfied with sub zero checking and savings interests.

SVB incident is also making more and more people realize that they are ripped off by banks. Unfortunately, that might mean some more ‘bank runs’ will happen as more customers are withdrawing cash from their bank accounts and putting them to higher yielding Treasury bills, ETFs like USFR, TFLO or BIL and/or money market funds. Such a ‘run’ will definitely create more pains for banks, especially for those that have tied up money in long term bonds similar to SVB. In this regard, we are afraid the current crisis is far from over.

Bank On My Own

With the advent of online electronic transactions and especially much easier way to directly lend money to a borrower (such as US government — when you buy a Treasury bill, you are effectively lending money to the US government). March 15, 2021: Make Your Own Private Bank had more detailed discussions. To quote:

  • Deposits: a bank account acts as a place to hold your money. It’s a common place to receive payments (deposits) from your work (i.e. salaries, bonus, etc. like a direct deposit) or from other transactions.
  • Savings: Most of time, your money stays in so called checking or savings accounts and accrues some interests the bank pays. Behind the scene, the bank actually use your money to lend to others. Thus, the bank profits from the difference from loan’s interests and the interests it pays you. Often, this difference is very lucrative. Unfortunately, it’s also a source where greed develops unbound: to derive much higher profits, banks might venture into other higher risky lending practices (such as subprime house or car loans) and/or over leverage (lend way too much than it holds). This is a much bigger topic beyond this newsletter.
  • Bill pays: a bank also provides or enables payment service so that you can pay bills (credit card bill, tuitions, mortgage payments, rents etc.) from your account. In old days, payments are mostly through paper checks and bank transfer. Paper checks are rapidly becoming obsolete as more and more often, people and businesses are getting accustomed to electronic payments. For example, these days, you can pay rent to your landlord who has an email associated with his bank account. Granted, there are still some who insist on getting physical checks and then deposit them to a brick and mortar bank branch. But as we said, this practice is becoming less and less popular.
  • Loans: sometimes, you might want to borrow money from your bank. Most times, people borrow money either through a third party or through a credit card debt. Some common loans are like car loans, house mortgages and student loans, all of which can be obtained through a third party. For example, to get a house mortgage finance, you work with a broker who does all of the necessary work for you. At the end, your mortgage might be from Wells Fargo, Bank of America or other sources. To some extent, you really don’t need to care where it’s from. You just need to regularly fulfill your obligation  (such as making a monthly payment). Similarly, your car dealer might be able to help you to get a car loan, often not from your bank, but from another bank that has lower (or lowest) interest.
  • Some miscellaneous services such as ATMs and certification of accounts.

The newsletter then proceeded to discuss how to achieve each function. Specifically, one can do the bulk of savings (and even bill pays and ATMs) in a brokerage account. You can buy Treasury bills, Ultra short term Treasury ETFs (USFR, TFLO and BIL, for example) or invest in a Treasury/Federal money market fund such as such as Vanguard Federal Money Market Fund if available.

Doing so enables you to get rid of banks as middle men and you will get much higher returns. You are effectively managing your savings part (with a little bit efforts) on your own. What’s more, it’s a bit more surprising to many that your money is actually safer than being in a bank. The reason is that if you invest in a Treasury bill directly, even though you buy the bill through a brokerage, the brokerage is just acting as a custodian (of your bill certificate). In the event of the brokerage bankruptcy, its creditors can’t take possession of your certificate. The certificate is still yours and you can sell it in an open market to get your money back.

We have long argued for this ‘Bank On My Own’ approach.  The following previous newsletters touched on this subject:

There are many ways to smooth out or reduce efforts to Bank On My Own. Interested readers are strongly suggested to read through the above newsletters.

Market overview

We are in a bind: inflation is still high, labor cost is still high though the unemployment rate in last month has moved up to 3.6% from 3.4%. However, we are starting to see cracks in various segments including the banking (the SVB failure discussed above) and ultra low home sales (and mortgage applications). It’s increasingly likely to have a more clear picture in the coming months. For now, markets are swinging in both directions, trying to approximate the right direction. At the moment, stocks are turning in a downtrend direction.

As always, we call for staying the course which is guided by some well defined and sound strategies:

  • For strategic allocation (buy and hold) investors, ignore the current market behavior. Remember, as what we have emphasized numerous times, when you choose and commit to a strategic portfolio, you essentially know and commit that your investment horizon (or the time you need to utilize this capital) is 20 years or preferably much longer given the current high valuation. As we pointed out, if your investments are those diversified (index) funds such as an S&P 500 index fund (VFINX, for example), you know your money is in some solid ‘business’ that eventually (20 years later and preferably many more years later) will deliver some reasonable returns. As long as you are comfortable with this thesis, you should sit tight and forget about the current gyration.
  • For tactical investors, again, you have to ignore the current market noise. Furthermore, you should follow your strategy rigorously, especially in a time like this. Human emotion, both optimistic and pessimistic, and human desire, both greedy and fearful, are your worst enemies. This has been shown to be true time and time again.

Stock valuation has dropped and now valuation is becoming less hostile. However, it is still not cheap by historical standard. For the moment, we believe it’s prudent to be extra cautious. However how serious a correction might be, we have confidence in the US economy in the long term and thus in the stocks in aggregate. We just need to manage through interim losses carefully.

We again would like to emphasize that for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.

Enjoy Newsletter

How can we improve this newsletter? Please take our survey 

–Thanks to those who have already contributed — we appreciate it.

Latest Articles

Any investment in securities including mutual funds, ETFs, closed end funds, stocks and any other securities could lose money over any period of time. All investments involve risk. Losses may exceed the principal invested. Past performance is not an indicator of future performance. There is no guarantee for future results in your investment and any other actions based on the information provided on the website including, but not limited to, strategies, portfolios, articles, performance data and results of any tools. All rights are reserved and enforced. By accessing the website, you agree not to copy and redistribute the information provided herein without the explicit consent from MyPlanIQ.