Why I avoid investing in banks
Archived article: please remember tax and investment rules and circumstances can change over time. This article reflects our views at the time of publication.
The Quality Shares Portfolio doesn’t hold any bank shares. Nor do I envisage this changing any time soon.
Why? The vast majority of banks have impenetrable accounting, in my opinion, and I simply don’t understand them. And even if I did, I still wouldn’t invest, because they don’t meet my strict quality criteria.
Banking is an extremely competitive industry that relies almost entirely on perception and belief. The business model only works if depositors have faith their deposits are secure. Once that faith erodes – irrespective of how founded the fears are – you are in real trouble.
The risks of investing in banks are further magnified by leverage. Banks rely on a very small amount of equity to fund their assets. This means a small decrease in assets can potentially wipe out most or all of the equity. If a few loans go bad, or you get your sums wrong, the consequences can be disastrous.
To compound matters, a lot of banks have a mismatch between their assets and liabilities.
A simple explanation
Imagine you have £1,000 in an instant access account at ‘Bank of Charlie’. I decide to keep that deposit as cash. A year later, you ask for your cash back and I wire you the money. The only problem is, I’ve made little or no return on that cash and shareholders of Bank of Charlie aren’t amused by the measly profits.
Imagine now if I took your deposit and invested it in a 10-year government bond. By locking the money away, I can earn higher interest and higher profits. But there’s a catch. A year later, you decide you want your cash back. The 10-year bonds I bought are now only worth £800, because interest rates have risen. When I sell these bonds (assuming I can), I’m faced with a £200 shortfall.
This was the main issue behind the recent failure of Silicon Valley Bank. It invested deposits, which could be withdrawn any time, in long-term debt. As interest rates rose, the value of those debt instruments fell, creating a liquidity crunch when multiple depositors asked for their money back at the same time. Widespread fear did the rest.
Picking up pennies in front of a steamroller
What’s more, despite the risks, most banks make modest returns. In the good times, they are picking up pennies in front of a steamroller. In a crisis, they can easily be wiped out. In my view, the returns simply aren’t worth the risk.
And I believe the returns banks earn are likely to get worse from here, not better.
Banks are integral to the economy, so regulators scrutinise them closely. Regulations have become more onerous since the 2008/09 financial crisis. This latest debacle is only likely to exacerbate that trend, making it even harder for banks to earn decent returns.
Put all that together and 99.9% of banks are uninvestable for me, no matter how ‘cheap’ their shares appear to be. Call me boring, but I’d much rather invest in resilient, simple-to-understand businesses that are strengthened by a crisis, rather than hobbled by it.
Apply online now: Quality Shares Portfolio, managed by Charlie Huggins
The Quality Shares Portfolio, managed by Charlie Huggins and exclusively available through Wealth Club, is a portfolio specifically designed for people who are genuinely interested in investing.
It’s a portfolio of 15-20 global businesses chosen for their resilience, financial strength and pricing power.
It is profoundly different from any other investment you might hold in two key respects. The first is the level of information, insight and transparency it provides (you can see an example here). The second is in the investing approach itself.
You can invest in the Quality Shares Portfolio online, if you’re a high net worth or sophisticated investor. The minimum investment is £10,000; you can invest in an ISA, SIPP or in a General Investment Account, subscribing new money or transferring existing investments.
Liked this article? Register to receive the next one straight into your inbox.
Wealth Club aims to make it easier for experienced investors to find information on – and apply for – investments. You should base your investment decision on the offer documents and ensure you have read and fully understand them before investing. The information on this webpage is a marketing communication. It is not advice or a personal or research recommendation to buy any of the investments mentioned, nor does it include any opinion as to the present or future value or price of these investments. It does not satisfy legal requirements promoting investment research independence and is thus not subject to prohibitions on dealing ahead of its dissemination.