A smart man learns from his mistakes, a wise man learns from the mistakes of others.
Many of my clients are in the tech space and thus affected (at least emotionally) by SVB’s failure in early March. On this week’s podcast I will give you the wisdom gleaned from the downfall of the bank that was not too big to fail.
I break it down into three parts:
- What does the collapse of SVB mean for me?
- First, single stocks are very risky. Use low cost index funds to reduce the risk of having all your eggs in one basket.
- Second, go government. Don’t leave your cash sitting in a bank. Invest the cash you don’t use on the regular in a government money market fund. Why? Because it is fully backed by the United States Treasury.
- Lasty, be aware of who you are doing business with. Who is the producer of the financial products you use? Are they credible? What risk is associated with their brand?
- Why did SVB fail?
Banks are a business. They offer products to consumers, in the form of accounts and returns. SVB used its clients’ deposits to invest in other businesses and the market at large, resulting in profits for both the bank and its depositors. Until those investments took a dive. Suddenly, clients want their money back but the bank doesn’t have it to return.
- Long-term bonds: The Golden Egg
When you buy a bond you get two things over a set period of time: an interest payment each year and the return of your principal at the end of the time period. So, here is an example of how bonds lose value:
- Say that you buy a 10-year golden egg for $10k that pays you $100 per year in interest for 10 years, then you get your $10k back.
- Three years later, the government raises interest rates, and a new platinum egg is released. That egg will pay you $400 in interest over ten years. Suddenly your golden egg is now only worth $9k because everyone would rather have the platinum egg.
This is what happened to the 2019 10-year US Bond that SVB bought 3 years ago. It is still paying 1% ($100 per year) but is only worth $9k today. So, if SVB is forced to sell that bond today to pay back a customer, it only has $9k to give back to the customer!
Tune in to hear more about the lessons that should be learned from SVB’s collapse. And if you were affected by the bank’s demise and have questions or just want to chat, reach out!
Why Silicon Valley Bank failed, and what does it mean for you? What lessons can we learn? Hello, welcome to Financial Life Planning. I'm your host, Mike Morton. And unfortunately, Matt is not here today. So it's gonna be a solo episode with just me because I wanted to get this out and go over why Silicon Valley Bank, SVB went down. And I know if you've read the news already, you know a lot about this. But really, I want to take the angle of what can we learn, what does it mean for you, as an individual investor, as a busy parent? What lessons can we take away from this? So I'm going to split this podcast into three sections, what I feel is the most important to maybe the least important. So the first is, what does this mean for you? What lessons can we learn from this? What takeaways should we take? What can you do today to protect yourselves in the future? The second thing is, why did it fail? Sure, you've read a lot about this, but I'll try to break that down into some plain English. Why did Silicon Valley Bank go down? And third, why do long-term bonds go down or lose value when interest rates go up? So in the last year, the Fed has been raising interest rates, which means bonds have gone down in value. And I want to explain why that is. It's a mathematical equation. It is pretty simple logic, but I wanted to go into that again. So let's take, first things first, what does this mean for you? What lessons can we learn from this episode? I've got five things that we can take away here. The first is that single stocks are very risky. This is not a bailout, Silicon Valley Bank SVB, the shareholders, and the management that owns the ownership of that business are not getting bailed out. So they have lost all of that money. If you had shares in SVB, that has gone to zero. And what we can take away from that is single stocks, single investments, and single businesses are very risky, they can go to zero, we know this from Enron, I remember Enron or Pets.com, back in 2000. So this definitely happens, it's a thing. And we've glossed over it most of the time unless you are involved and had a significant portion of money in one of those businesses, but single investments are very risky, they can go to zero. And this is why I love to use low-cost index funds that spread risk across thousands of companies both here in the US and internationally. So we're not going to necessarily hit those home runs, we're not going to get something doubling within a week or two. But at the same time, it's not going to go to zero. And that's a big deal. The second point, is the FDIC insurance doesn't matter, you know, that you are only insured up to $250,000 per account type per owner, there are some details, a few have over that amount if you're lucky enough to have millions of dollars, doesn't matter if you have that sitting in one bank is that important? Obviously, the government stepped in and backed all the clients or customers of SVB to make them whole, even if they had more than the 250 that were insured. So I think it's important to be aware of where you have money and spread it across different banks, especially looking at local banks. Again, you have your money in one institution and if you're literally holding it in cash in that bank, it could be a problem. If you have investments spread out, that's a different matter. And I'll talk about that in a second. So it's not oh my gosh, I've got 1.5 million in fidelity, is that going to be a problem? Depends on how much is actual cash, okay, that really matters. And when you talk about fidelity and Vanguard and Schwab's, those institutions probably fall under that ‘too big to fail’. So I'd be less concerned about that. So I'm still not super concerned about FDIC insurance. I think it's good to be aware of, depending on where you have your money if you have a lot of money in a local credit union, a very local bank. Yeah, that could be something you really want to take a look at. If it's one of these massive institutions a Vanguard, a TD, a Schwab, or Fidelity, I'd be less concerned but I still think you want to get that into some investments. This leads me to number three, using government money market funds. Now, when you're holding some cash if it's not invested in the stock market or into a big bond portfolio or something. You got that cash readily available. Many of the larger brokerages have money market funds, I highly recommend using these, especially today because you can get over 4% interest on using the funds rather than have cash in your local bank account. Put that cash into Fidelity, Vanguard, Schwab and use the money market funds and specifically like the government money market funds, they pay a little bit less interest, but they're fully backed by government treasuries and US bonds, all of that so they're a little bit better. You know the prime… you'll see prime money market funds and government money market funds. I was always sort of agnostic, and the prime does pay a little bit better. But now I'm leaning towards maybe using the government money market funds just to have the full faith and backing of the US government, and you're losing just a little bit of interest for having that. fourth thing, we're keeping track, what about all the stocks that you own at Fidelity or Vanguard? Is that going to be trouble if one of those institutions starts getting in trouble? Or maybe it's a smaller institution, I keep picking those really big names, but there are lots of different brokerages. So what if you have some investments held at that brokerage, or whatever you own is still yours? Now there's another insurance called SIPC insurance. And that is for your investments, and it's good up to 500,000. But that's really for fraud. All right. So if someone you know said, Hey, here's your bank statement, like a made offset, you got $500,000 with me, here's your bank statement, and he really didn't have it, it literally is just fraud, then you're protected up to $500,000 for that. So I'm not really talking about that side of things. But if you own individual stocks or you own ETFs or you own mutual funds, you own that thing produced by that company, if you own a Vanguard mutual fund, and if you hold it at some brokerage, like M1 Finance or you hold it at one of these smaller places, I'm blanking on names at the moment. But if it's not held to Vanguard, but you own a Vanguard mutual fund, then that's produced by Vanguard, you own a thing, you own that in your name. And if Vanguard gets in trouble, then you might be in trouble. Okay, because it's a Vanguard mutual fund. It's a product produced by Vanguard. So that's where you want to be careful of, I'm always careful of ETFs and mutual funds, who's the producer? Is it a Vanguard or a BlackRock, those would be those I share funds is a fidelity fund, is it a Schwab ETF that we're using, so be aware of who's producing that product, because that's what you're buying into. And that's what you hold. And you do own that. So if you own an individual stock, you're going to be the owner of that stock, no matter where you hold it. And finally, the fifth thing, is your cash, what else can we learn from this, make sure you have your cash invested earning some money, I just talked about that. But I was shocked to hear how many companies had just hundreds of millions of dollars sitting in SVB, not even invested in any way, just literally sitting in cash. Now, maybe SVB was paying them 2, 3, or 4%, I don't know. But usually, banks are paying like 1 or 2%, okay, of interest on your money. And right, I told you earlier on money market funds, you can get 4 or 5% right now. So Roku had over 485 million in cash. And even if they could earn an extra 1%, they didn't have it sitting in SVB. If they just put it into a money market fund, like I just referenced, they could be making over 5 million a year of just interest, $13,000 a day, just sitting there $13,000 a day, just 1% extra interest, rather than having the cash just sitting there. So do not have your cash just sitting around. Now, if you're working with cash, I get it 10, 20, 30, 40,000 dollars of money in money out. That's what your paycheck gets deposited in your credit cards, of course, all that stuff. But if you have emergency funds or other cash, do not just have it sitting literally in cash in your local bank account, earning that 1 or 2%. Make sure you're getting at least 4% on that money. So those are the five things that we can learn from this failure. Now, as I told you, in the next segment, I'm going to go into why specifically, did SV fail? Are you ready to create your ideal lifestyle? Let's discover what's most important to you and design a plan to have more of that in your life. Go to meet Mike morton.com. All one word, meet Mike morton.com. So why did Silicon Valley Bank fail? Remember that a bank is just like any other business, it's a business. So think of it that way. Don't think of it as a bank. And I put money in and my money is held there. And then I get money out. That's how you're used to using a bank. But a bank is a business. So think of it that way. So if I'm going to start a business, and I'm gonna call this thing a bank, I might have some products and services for my clients that they can hand me money, and I might even get some interest. I'll give them a free check. So they can write checks for access to their money. So there are all these products and services as part of the business of a bank. Now if I'm starting a bank, how am I going to make money on my business, I want my business to be successful, I'm going to start and so I want to make money in my business year in and year out. One major thing that I can use is cash that people are giving me, I have services that I'm providing, but people give me cash, and they're gonna want it back eventually. But in the meantime, I might have millions of dollars. And maybe I can use that to make money. That's a way that banks make money. So let's talk about specifics. Let's say, Julie, my friend Julie, lends me $10,000 because I say I'll give her $100,000, $100 a year. So she thinks, oh, this is good. I've got $10,000 sitting around, I'd love to, I'd love a free 100 bucks a year. So Mike here's $10,000. And I give her $100 a year. That's it. And she says, great! And I say, oh, my gosh, Julie, thank you so much. But you are a sucker, my friend. Because I'm going to take your $10,000. And I'm going to invest it somewhere else. Let's call this a US Treasury bond. And I'm going to take your $10,000. And I'm going to get $200 a year from investing it. So I got an easy $100 a year for doing no work, I just turn around, take the $10,000 invested in Treasury, I'm getting $200 a year and I'm paying Julie $100 a year, boom, I am making money. This is good. I love this. Julie comes back to me a year later. And she says you know my kids need braces, oh boy, and I need that $10,000 back, this life is not so great as I thought I'm gonna need my $10,000. And I'm just like, I don't actually have your $10,000 because the thing I invested in, it's now only worth $9,000. I turn around and look and it's worth $9,000 It's gone down in value. How do I give Julie's $10,000 back, I was making $200 a year paying her $100 a year but she wants everything back now. And that US Treasury went from $10,000 when I originally purchased, it's only worth $9,000. Now if I need to get Julie's money back to her, I can only pay her $9,000. All right. So that's how SBB went down. But as simple as that whole bunch of people wanted their money, SVB turned around and said, oh, let's give them their money back. Oh, we don't have the cash because we're in a business of making some money for us and our shareholders and our employees to pay our employees and everything. And what we invested these millions of dollars into has gone down in value. There, you've read this, they were medium-term, long-term, US government bonds, and they went down in value. So they couldn't redeem, they had to redeem them, they had not $10,000 only $9,000. And so they couldn't pay back all their customers. So that's literally how it failed. It's called a bank run. Everyone wants their money at the same time. And suddenly, oops, we don't have the money, because we're in the business of trying to use those deposits to make more money to have a business. And so the question is, there was a few questions. Of course, banks are regulated. So there are all kinds of rules specifically around that business. So why did that happen? I'm gonna leave that alone for now. But why do long-term bonds go down? Why did SVB you know, backed by the US government and seems very safe, why did those bonds why were they worth less as interest rates have gone up? So that's the third segment. So hopefully, that makes sense as, to why SVB actually failed. Everyone's trying to get their money. I'm running a business called a bank. And to make money, I used all that. And so I just literally don't have it at the moment. And unfortunately, what I used it for, hasn't gone up in value, that would be easy. Sell it, everyone makes a profit, but it went down in value. So we'll go into why long-term bonds go down when interest rates go up. So why do the long medium-term or long-term bonds go down when interest rates go up? Remember that a bond is an IOU, so I'm lending some money to somebody, and they're going to pay me back some interest payments, and then they're gonna pay me back the money I lent at the end, that's typically how these things work. Now, you're used to it from maybe a mortgage, the bank has lent you $200,000 And you're going to pay it back over 30 years. Now that's amortized so that you pay equal payments over 30 years. And the word amortize means that the interest and the principal are all getting paid back over 30 years. And it's just a math equation to figure out what are those equal payments, so that at 5% interest on $200,000, and you're paying it down over time, so the principal goes down, so the interest payments actually go down, but with a math equation, you can figure out equal payments over a period of time, 30 years, and you're paying the principal and interest. Typically, the way bonds work, when you talk about investing in bonds, government bonds, company bonds, what it is, you're gonna give them the money, and you're only going to get interested back. So it's interest only, and then you're going to get all the money back at the end. So if I invest $10,000, at 1%, I might get $100 a year, and then in five years, I get all $10,000 back. Okay, so that's how these types work. So why does the value of that bond, that $10,000 bond that one thing that I purchased for $10,000, why does it go down as interest rates go up, here's the story. Let's say three years ago, I have $10,000. And I go to the market, and I buy a golden egg. Alright, and the golden egg gives me $100 a year. So I purchase a golden egg for $10,000, and for the next 10 years, I get $100 a year from the egg. And at the end, I'm going to get my $10,000 I'm going to give it back and get my $10,000. So this is great, for the next 10 years, I'm getting $100 a year, instead of just having that $10,000 sitting under my mattress, I now have a golden egg. So I got this golden egg, give me $100 a year. It's awesome. That was three years ago. And fast forward to today. And I've saved another $10,000 of cash. So I go back to the market, and now they've got platinum eggs. And I was like whoa, Platinum eggs what do they do… the platinum makes you 400 bucks a year. Okay, so you know, buy it for $10,000 The Platinum egg, I'm gonna get $400 a year for the next 10 years. Then bring the platinum bag back. And I get my $10,000 bag. Oh, this is so good. It's so good. So I grabbed a platinum egg. So now I've got a gold egg that I got. Three years ago, I've got a platinum egg so two eggs. And I'm getting $500 a year from my two eggs. Now I'm thinking, Man, I wish I had two platinum eggs right? The gold that cost me $10,000 The Platinum may cost me $10,000 I want another platinum egg. So I go to my friend Matt, who's not here today. So I can say Matt, this is a great deal. I've got this golden egg, it gives you $100 here you want 100 bucks a year. Of course, I want 100 bucks a year cool. Give me $10,000. And I'll give you this gold egg. So I'm thinking to myself, I'll get the $10,000 I can grab another platinum egg. Matt gives me $10,000 and I'll give you this golden egg, get 100 bucks a year and in seven years, you're gonna get all 10,000 back. Now, Matt gets a little bit wiser and he says wait a minute for $100 a year you want to sell me the gold egg for $10,000. But I know this market. And for the same $10,000 I can get a platinum egg. And I'm gonna get my 400 bucks a year, not your measly 100 bucks a year. So your gold egg Mike is not worth 10,000 alright, because it's only getting 100 bucks a year. And today, I can go get a platinum egg. So I'll give you say $9,000. I'll give you $9,000 now, I'm gonna get my 100 bucks a year and then in seven years, I get my $10,000. So I only invest $9,000 100 bucks a year $10,000 when I get it later. So that sounds like a pretty decent deal to me. So now you can see that Matt says the gold egg I got a few years ago that I paid 10,000 for today is only worth $9,000.And that's exactly how the bonds go down in value as interest rates rise when you can get 4% interest for 400 bucks a year, that thing a few years ago, were you getting 1% interest, it’s just not worth $10,000 anymore. It's only worth say $9,000. Again, it's a math equation. Seven more years at 1% plus $10,000 at the end is worth how much given today, I can put in I can get 4% over 10 years. Alright, so now you can see some of the numbers in the math. So bonds and interest rates always move up and down in opposite directions. So when interest rates rise, bond values fall. And the opposite is also true as interest rates drop, the value of your bonds goes up. Now, is it that simple? Sometimes yes, if you have very short bonds, if they're doing a week or a month, this is exactly how it works. Money market funds fluctuate very much I wouldn't say lockstep but then four weeks or so it flows through. So as the Fed raises rates, then that money market is going to dip in value a little bit but then it's going to be making more interest. All right, medium and longer bonds fluctuate more with those interest rates with 30-year bond rates changing by 1%. A 30 year bond is going to move up and down in value a lot faster to that change. It's more sensitive to change. So medium and longer-term bonds are more sensitive to changes in interest rates. And now hopefully that small example shows you why my golden egg that I bought for $10,000 is now only worth $9,000. And that's how SVB got in trouble. Thanks for joining us on financial planning for entrepreneurs. If you liked what you heard, please subscribe to and rate the podcast on Apple, iTunes, Google Play Spotify wherever you get your podcasts, you can connect with me at LinkedIn for Morton financial advice.com. I'd love to get your feedback. If you have a comment or question, please email me at financial planning Until next time, thanks for tuning in. This recording is for informational purposes only, and should not be considered for investment advice or opinions expressed as our of the date of recording. Such opinions are subject to change. We do not guarantee the accuracy or completeness of the data presented here.