How Safe is Your Money?

Whenever a big bank collapses it gets just about everyone’s attention and begs the question: How safe is your money?

Back in 2008, the banks that failed had balance sheets filled with questionable mortgage-backed investments. Remember sub-prime mortgages and collateralized debt obligations? In hindsight, it was no wonder they failed. So, what toxic investment was it this time, the one that caused Silicon Valley Bank (SVB) to fail?

There were many reasons that contributed to SVB’s downfall, but one particular investment stood out. I assumed it would be something super-risky, like a too-large investment in a small tech company or cryptocurrency. Nope. It was an investment in treasury securities, a fixed-income investment that is supposedly among the safest investments in the world.

There’s a good chance your investment plans are invested in these same treasury securities that helped do in SVB. By examining their plight, you can make sure what happened to them never happens to you! To better manage what I call the not-so-risky side of your investment plan, you need to understand the two types of risk associated with treasury bonds and other fixed-income investments:

Business Risk

Business risk is simply the ability of the issuer to pay back the “loan” plus interest. That’s what you’re doing when you purchase a fixed-income investment: You’re loaning money to the issuer (bank, government, or corporation) for a fixed amount of time in return for a fixed rate of return.

For example, money loaned via a corporate bond to a small start-up company has a lot more business risk (and a higher interest rate) than bonds issued by a Fortune 150 company. The latter is much less likely to get into financial trouble and put your money at risk.

Fixed-income investments issued by the federal government carry the least amount of business risk because Uncle Sam has more money and power than anyone. Obviously, the federal government didn’t default on SVB’s treasuries, so the culprit must be the other type of risk—interest rate risk.

Interest Rate Risk

Interest rate risk is the chance of interest rates moving higher after locking in a fixed rate of return. If rates move higher after the purchase, the market value of the investment drops, despite who issued it. The longer the holding period to maturity, the bigger the corresponding drop in market value.

Pretend you purchased $1,000 worth of 10-year treasury bonds on January 18, 2023. Your fixed interest rate would have been 3.39%. On March 2nd, your golden retriever swallows her squeaky toy and requires emergency surgery. Lacking a sufficient emergency reserve fund, you’re forced to liquidate your treasury at a big loss.

Why the loss? On March 2nd, newly issued 10-year treasuries were paying 4.08%, a nearly 3/4% increase over your older bond’s interest rate issued less than 2 months earlier.

No one’s going to pay you the full $1,000 price you bought it for. On March 2nd, that same $1,000 buys a significantly higher interest rate than yours on a newer issue of the same treasury security you have. That’s why the market value of fixed-income investments drops when interest rates rise. The opposite is also true: When interest rates fall, the market value of previously issued fixed-income investments rises.

Let’s further pretend your golden retriever was smarter than she looked and coughed up the squeaky toy rather than having it lodged in her intestine, saving you the expensive vet bill and the liquidation of your investment. Your bond’s market value on April 7, 2023 still isn’t worth what you paid for it, but it’s close. Interest rates on 10-year treasuries have fallen back down to around 3.5%.

If you decide to hold your bond until it matures in January of 2033, you’re guaranteed to get your full $1,000 principal back, plus the 3.39% interest, assuming things don’t go to hell in a handbasket. This is how bonds and similar fixed-income investments work.

When depositors got wind of SVB’s depleted balance sheet (lodged squeaky toy), they feared the worst and withdrew their money. Add a few zeros to the cost of the vet bill and you get the idea. SVB had no choice but to liquidate their depleted treasuries when the run on the bank accelerated, locking themselves into a nearly 2-billion-dollar loss.

The lesson to be learned here? Don’t invest in riskier long-term bonds for the short term unless it’s with money you can afford to lose.

The Safest Fixed Income Investments

When you’re about to spend money, you don’t want to have to take a big loss to get it like SVB. That’s why your emergency reserve fund and the money you’re planning to spend in the next couple of years should be invested in the safest of investments, the ones with the least amount of business and interest rate risk. That list does not include longer-term treasuries.

FDIC-insured certificates of deposit (CDs), high-yield savings accounts, and money markets are the safest investments you can make. FDIC insurance extends to $250,000 ($500,000 if a joint account). This insurance is per account.

You might remember me going on previously about the importance of not settling for a lousy rate of return in these safest of all accounts. Read this excellent article by Christy Rakoczy and don’t settle: Best Savings Accounts with 5% Interest [2023]: Get Your Money’s Worth.

If you’re richy rich, open multiple insured money markets or high-yield savings accounts with different ownership designations for maximum safety. For example, if you’re married, you can insure 2 million dollars of investments using different accounts with the same bank, savings and loan, or credit union:

Inflation Risk

The problem with this group of investments is inflation. Because they’re the safest, returns are usually below the rate of inflation. When that happens, even though you aren’t literally losing money, given the safety of the underlying investments, you’re still losing money because your return isn’t keeping up. That’s why for funds you don’t need right away, riskier investments should be added to your investment plan to hopefully secure a higher rate of return, one that at the very least beats inflation.

That’s where medium and longer-term fixed-income investments come in, which carry more interest rate risk and a higher potential return. Assuming your time horizon for investment is over 4 years, investments from the risky column can be added too for hopefully even higher returns. The longer the time horizon for investment, the riskier the investments you’ll want to add to the mix, regardless of your risk tolerance.

Your Perfect Mix

The investments listed below range from least risky to most risky. Keep in mind all the investments in the Risky Investments column are risky: You could lose your shirt with some. Others farther down the list you could lose your shirt and pants.

That’s why coming up with your own risky to not-so-risky ratios and dynamic diversification for your investment plans is so important. Add in my risk management strategies, and you’ve got one of the most powerful investment plans on the planet!

What’s my perfect mix of risky and not-so-risky investments?

How can I achieve financial independence sooner rather than later?

What can be done if I’m behind on my retirement savings?

I answer these questions and a lot more in my book DIY Stock and Securities Investing. The 5×8 paperback version is 249 pages packed full of information and examples to help you reach any financial goal, however daunting. You’ll also appreciate the detailed Table of Contents that helps you quickly find the information you need.