My Credit Suisse friend phoned me in a panic. His employer stock was tanking, and the money in his deferred compensation plan could be lost if the firm went bankrupt. A banking crisis can lead to a personal financial crisis very quickly. Given the recent turmoil in the banking world, investors should take time and review how their nest egg may be exposed in a banking crisis.
Here are the details on five things you should know:
FDIC Insurance
First and foremost, understand how the FDIC insurance works. FDIC coverage is calculated per depositor, per institution and per ownership category. For example, a husband and wife have separate, individual bank accounts with FDIC insurance on $250,000 of deposits at the same bank. Joint accounts are insured separately, and as a result, they each have FDIC protection on up to $250,000 in a joint account or $500,000 combined for a total of $1 million of FDIC protection at the same bank (the two individual accounts and the joint account).
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For balances above those limits, our clients access a network of thousands of banks and establish certificates of deposit with banks nationwide, each backed by the maximum FDIC insurance, but with one banking relationship. The result is a diversified banking experience that can save the client time and money for opening multiple accounts.
Money Market Funds
Money market mutual funds commonly used in brokerage investment accounts are not FDIC-insured (there is SPIC insurance if the custodian fails, but that does not protect against investment loss). Contrast this to money market deposit accounts (MMDs) offered by banks, which may sound similar but are FDIC-insured. Both try to earn their customers more interest than a checking account, and both invest conservatively.
However, some money market mutual funds can own short-term bank notes. These notes may pay more interest than Treasury bills, but they can also carry more risk. For now, investors who use money market mutual funds may want to stick with funds that invest only in U.S. Treasuries and avoid money market funds that hold bank notes till things calm down.
High-Dividend ETFs and Funds
On the surface, a focus on dividend stocks sounds intriguing. Dividends, after all, make up a large chunk of the S&P 500 index’s return — 32% of the total return for the S&P 500 index since 1926 can be contributed to dividends (source: S&P Global).
However, a focus only on dividend-paying companies may expose you to a greater number of financial companies like banks and insurance companies who are known for their dividends. The Vanguard High-Dividend Yield ETF (VYM) has 21.28% in Financial Services versus roughly 14% for the Vanguard S&P 500 Index Fund (VFIAX).
The lesson here is do your homework: A focus only on dividends may hold more financial stocks than the index.
Structured Products
Structured notes are offered by banks to investors and institutions to capture some upside of an investment index but limit the downside. They have maturity terms like 18 or 36 months. Structured notes are complicated and not suitable for everyone.
A key risk to structured notes is they are based on the claims-paying ability of the issuing bank. If the bank fails, the note fails (only principal-protected notes have FDIC insurance). We call this credit risk.
Investors in structured notes need to know their credit risk. The failure of SVB and Credit Suisse underscores this. I am not for or against structured notes — I use them in some situations — but investors should consider diversifying their issuers to lessen the dependency on any one bank.
Deferred Compensation
Money in a non-qualified deferred compensation (NQDC) plan is subject to the creditors of the employer in the event of bankruptcy. In a deferred compensation plan, employees defer a bonus or portion of their salary today for the promise of payment in the future.
However, deferred compensation plans are not covered by the Employee Retirement Income Security Act (ERISA) rules like in 401(k)s, they do not have the same protections. In the event the employer goes bankrupt, money in a deferred compensation plan can be used to satisfy creditors. For this reason, be careful how much you contribute to non-qualified deferred compensation plans. Employees of banks or other financial institutions should pay even closer attention.
The same goes for managing your employer exposure. Like my Credit Suisse friend, things can happen quickly — the employer stock can drop rapidly, the deferred compensation plan can be at risk, and job security can lead to job insecurity. Proper financial planning before a crisis can help.
Final Thoughts
George Patton once said, “We can prepare for the unknown by studying how others in the past have coped with the unforeseeable and the unpredictable.”
Let’s not let the lessons of the recent banking crisis go ignored. In my client portfolio reviews, we discuss banking relationships, FDIC limits, money market funds and other banking exposures like structured products, financial stocks and employer deferred compensation, to name a few. We can’t predict, but we can prepare. That much we can bank on.
The author is an independent fee-only Certified Financial Planner. For a complimentary banking and investment review, please email maloi@sfr1.com.
Although money market mutual funds seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in money market mutual funds. The S&P 500 Index is a market capitalization-weighted Index of 500 widely held stocks often used as a proxy for the US stock market. Investors cannot directly purchase an index. The material is solely for information purposes and is not a solicitation or an offer to buy or sell any security.
Investment advisory and financial planning services are offered through Summit Financial LLC, a SEC Registered Investment Adviser, 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600. This material is for your information and guidance and is not intended as legal or tax advice. Clients should make all decisions regarding the tax and legal implications of their investments and plans after consulting with their independent tax or legal advisers. Individual investor portfolios must be constructed based on the individual’s financial resources, investment goals, risk tolerance, investment time horizon, tax situation and other relevant factors. Past performance is not a guarantee of future results. The views and opinions expressed in this article are solely those of the author and should not be attributed to Summit Financial LLC. Summit is not responsible for hyperlinks and any external referenced information found in this article.
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