How You Can Diversify Your Cash
How uninsured deposits have rattled nations and what to do with your cash (personal and business) - part of One Chart One Idea series
In the One Chart One Idea series, I hope to explain one key economic, financial, or business phenomenon simply and factfully within 3 to 4 minutes. I welcome feedback on the topics you love to know more about.
The collapse of the 16th largest bank in the U.S., the Silicon Valley Bank (SVB), on March 10, 2023, followed by the closure of Signature Bank on March 12, sent shock waves to the global financial markets.
How and why it happened are explained here, here, and here. The last one was an interview with the 2022 Economics Nobel prize winner, Professor Douglas Diamond, a bank run expert. What really caused SVB to collapse will only be clearer over time.
Two often-cited reasons explain the fall of SVB: (1) a concentration of deposits in the hands of VC-funded technology and healthcare companies (not smaller retail deposits) leading to a significant amount of uninsured deposits (over 90% of total) AND (2) a mismatch in the duration of the asset (the majority are long-dated Government securities bought before the Fed rate hikes) versus liability (flighty deposits which have become more costly as short-term rates rise) with little interest rate hedging.
Under the backdrop of a faster cash burn of the startups, the fastest interest rate rise in decades, a tight network amongst the VCs and startups, the sudden SVB’s announcement of their capital losses and equity raise, the convenience of online withdrawal, a lack of stress-testing and strict regulation, and the ease of online cash withdrawal, SVB, sadly, cratered at a rapid speed under a dramatic bank run.
Uninsured Deposits
Uninsured deposits have become a big concern for citizens, bankers, and company CFOs.
In the U.S. the Federal Deposit Insurance Corporation (FDIC) covers $250,000 per depositor, per FDIC-insured bank, and ownership category. Products covered include checking and savings accounts, money market deposit accounts, and certificates of deposit.
Deposits over $250,000 in a bank are uninsured. If a bank becomes bankrupt, depositors may not recover any of their uninsured deposits. The more corporate customers the bank has, uninsured deposits as a percentage of total deposits will be higher.
As of Q4 2022, the U.S. banks’ uninsured deposits were about 46% of the total deposits. Note Silicon Valley Bank and Signature Bank had around 90%, 2x the average.
The obvious question is, where can customers put their cash and sleep better at night?
How to Diversify your Cash Holdings
(1) Know exactly how much cash you have in each financial institution and diversify. Aim to keep your cash and cash equivalents (checking and savings accounts, CDs, Money Market Accounts) below $250,000 at any financial institution. CFOs who hold concentrated cash reserves at any institution will prioritize diversifying cash holdings while considering the banking relationships and terms.
It is possible to increase your FDIC deposits. The FDIC covers $250,000 for individuals’ qualified accounts but also up to $250,000 for each co-owner of a joint account, according to Bloomberg.
“The easy step is if you’re married, you can get $1 million of FDIC coverage by having a personal bank account in your name, a personal bank account in your spouse’s name and a joint account,” said Keil.
Note that banks determine how much they will give you on their products, which can be much lower than the Fed Funds rate.
(2) Park your cash in Money Market Funds that invest in cash and debt-based securities with a short-term maturity. Money Market Funds have become attractive at a current yield of around 4.5%. At this time of heightened bank uncertainties, investors have been moving from Prime Money Market Funds, which invest in short-dated securities of corporates and banks, to those that invest in government securities only.
(3) Invest in ultra-short-duration bond funds. These are bond mutual funds that invest the majority of their assets in investment-grade fixed-income securities (government, agency, corporates) with a duration typically of less than one year. Investors have recently flocked to ultra-short government bond funds to minimize credit risks. Note the investment risks in ultra-short duration bond funds.
According to Barron’s:
Total inflows into money-market funds through mid-March [2023] were a net $96.8 billion, according to Refinitiv Lipper, the largest inflow over the first 2½ months of a calendar year since 2008. Short-term U.S. Treasury bond funds saw their third-largest monthly inflows on record — $10 billion — in February.
(4) Invest directly in government Treasury Bills (and Treasury bonds if the yield is steady or declining.) One advantage is that there are no fees or expenses, unlike Money Market Funds. The risk is the principal will decline if short-term rates continue to rise (if you sell before maturity.)
(5) Utilize cash management accounts (CMAs) at a brokerage or non-bank financial institution. Before you invest in securities in a brokerage account, or if your securities pay interest income or dividends, you can park your cash at the CMAs, which are insured (via third-party FDIC-insured banks) and earn some interest. CMAs offer checking account capabilities.
(6) Use a Sweep account. In your brokerage account, you can open sweep accounts to sweep cash above a certain threshold automatically into a money market/Treasury mutual fund at the end of each business day. This way, you can earn a higher interest rate with your idle cash before you put them to work in the market.
The security and cash in your brokerage account are protected by the Securities Investor Protection Corporation (SIPC) — up to a maximum of $500,000 per client for securities (including up to $250,000 for cash.) Investment losses are not protected.
Business owners and CFOs need to know when the sweep occurs — same or the next day. Also, the cash in the sweep account should preferably be held in the company’s name rather than that of the third-party bank. Also, there may be fees for the sweep account.
Takeaways
Volatile markets, economic uncertainty, banking crises, and tightening credit conditions all raise the antennae for investors on how to keep their cash safe.
The good news is there are several alternatives to consider, namely,
— Money market funds
— Ultra-short duration (government) bond funds
— Treasury bills and bonds
— Cash Management Accounts (insured up to a limit)
— Sweep Accounts
In investment, you learn not to put your eggs in one basket. Diversifying your cash holdings and knowing the risk factors are just as important.
The epic failure of SVB may offer another lesson: we will learn to burn less cash and preserve it more wholeheartedly. Your banks are tightening their purses anyway.
This article is for informational purposes only. It should not be considered financial or legal advice. Not all information will be accurate. Consult a financial professional before making major financial decisions.
Please feel free to check out my other stories in the One Chart One Idea series:
One Chart One Idea
I started my buy-side investment career in the mid-1990s as a fixed-income analyst in an international mutual fund company right after MBA graduation and became a Chartered Financial Analyst.