My friend at Credit Suisse called me in a panic. His employer’s stock was falling, and the money in his deferred compensation plan could be lost if the company went bankrupt. A banking crisis can very quickly lead to a personal financial crisis. Given the recent turmoil in the banking world, investors should take the time to review how their nest egg could be exposed in a banking crisis.
Here are the details on five things you need to know:
First and foremost, understand how FDIC insurance works. FDIC coverage is calculated per depositor, per institution, and per property category (opens in new tab). For example, a husband and wife have separate, individual FDIC-insured bank accounts for $250,000 in deposits at the same bank. Joint accounts are separately insured and as a result each have FDIC protection up to $250,000 in a joint account or $500,000 combined for a total of $1 million in FDIC protection at the same bank (both individual accounts and the joint account).
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For balances above these limits, our customers have access to a network of thousands of banks and create Certificates of Deposit at banks across the country, each backed by the maximum FDIC insurance, but with a single banking relationship. The result is a diverse banking experience that can save the customer time and money opening multiple accounts.
Money market funds
Money market mutual funds (opens in new tab) often used in brokerage investment accounts are not FDIC insured (there is SPIC insurance if the custodian fails, but it does not protect against investment loss). Compare this to money market deposit accounts (MMDs) offered by banks, which may sound similar but are insured by the FDIC. Both try to earn their clients more interest than a checking account and invest conservatively.
However, some money market mutual funds may hold short-term notes. These notes may pay more interest than Treasury bills, but they may also carry more risk. For now, investors using money market mutual funds may want to stick with funds that invest only in U.S. Treasuries and avoid money market funds that hold notes until things calm down.
ETFs and High Dividend Funds
At first glance, the emphasis on dividend stocks sounds intriguing. After all, dividends make up a large portion of the S&P 500’s return — 32% of the S&P 500’s total return since 1926 can be contributed to dividends (source: S&P Global).
Focusing only on dividend-paying companies, however, can expose you to a larger number of financial companies such as banks and insurance companies that 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 to do your homework: A dividend-only focus can contain more financial stocks than the index.
Structured notes (opens in new tab) are offered by banks to investors and institutions to capture some upside of an investment index but limit the downside. They have maturities like 18 or 36 months. Structured notes are complex and not for everyone.
A key risk for structured notes is that they are based on the ability to pay claims 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 bonds should be aware of their credit risk. The failure of SVB and Credit Suisse highlights this. I’m not for or against structured notes – I use them in some situations – but investors should consider diversifying their issuers to reduce reliance on any one bank.
Cash in nonqualified deferred compensation (opens in new tab) (NQDC) plan is subject to the employer’s creditors in the event of bankruptcy. In a deferred compensation plan, employees defer a bonus or part of their salary today for a promise of payment in the future.
However, deferred compensation plans are not covered by the Employee Retirement Income Security Act (ERISA) (opens in new tab) rules like in 401(k)s, they don’t have the same protections. In the event that an 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 more attention.
The same goes for managing your employer exposure. Like my friend at Credit Suisse, things can happen quickly – an employer’s stock can drop quickly, a deferred compensation plan can be at risk, and job security can lead to job insecurity. Proper financial planning before a crisis can help.
George Patton once said, “We can prepare for the unknown by studying how others in the past have dealt with the unpredictable and unpredictable.”
Let us not let the lessons of the recent banking crisis be ignored. In my client portfolio reviews (opens in new tab), we discuss bank relationships, FDIC limits, money market funds, and other bank exposures such as structured products, financial stocks, and employer deferred compensation, to name a few. We can’t predict, but we can prepare. That much we can count on.
The author is an independent fee-only certified financial planner. For a free banking and investment review, please email [email protected].
Although money market mutual funds strive to preserve the value of your investment at $1.00 per share, it is possible for you 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 for informational purposes only and is not an invitation or an offer to buy or sell securities.
Investment advice and financial planning services are offered through Summit Financial LLC, an 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 consequences of their investments and plans in consultation with their independent tax or legal advisors. Individual investor portfolios should be constructed based on the individual’s financial resources, investment objectives, risk tolerance, investment time horizon, tax situation and other relevant factors. Past performance is no guarantee of future performance. 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 reference information found in this article.
This article was written by and represents the views of our advisor and not the Kiplinger editorial team. You can check the advisors’ SEC records (opens in new tab) or with FINRA (opens in new tab).