The recent bank failures remind us of an important investing lesson. Just like we invest for our future, the bank invests for its shareholders and investors. The ultimate goal under both circumstances is to invest for a return. Obviously, what the bank does is different from what we individual investors can do, but the recent bank failures act as a reminder of what not to do.

In case you are wondering which bank failure I am talking about, you can go ahead and read an article on “What happened to Silicon Valley Bank and Why did it Fail?”.

I acknowledge the potential risks that niche banks face when operating in specific markets, and I do not intend to criticize their actions or decisions. Rather, I aim to draw parallels and extract valuable lessons that we can learn from their experiences. It’s crucial for us to remind ourselves of these critical investing lessons that both banking executives and investors should bear in mind. We must be more cautious in our investment decisions and avoid putting our hard-earned money, investments, and retirement savings at risk of significant losses or defaults.

Investing Lesson One: Diversify Your Risk

Banks that serve specific types of customers, such as startup companies or cryptocurrency platforms and users, are subject to the risks associated with those ventures. Investors are often warned to avoid concentrated holdings, such as a single stock, a large share of crypto, or even too much cash. Advisors always recommend investment diversification. It’s a many-layered blanket protecting you from risk. It begins with the major investment groups: stocks, bonds, and cash.

The bank during the COVID crisis purchased income-producing investments when interest rates were low. So that they are not holding on to cash, as that is not a wise idea either with large sums. So, what’s wrong with doing that? Well, that will lead to our second lesson from this crisis.

Investing Lesson Two: Make Realistic Assumptions

The banks assumed that interest rates wouldn’t rise as quickly as they did. They were thinking that this perfect scenario would play out and their investments would mature in time to meet any financing needs. They took a big risk of assuming counting on an outcome that favors a result you prefer.

They forgot that when rates are at historic lows, there is a good chance that sooner or later, they will rise. Just for those who don’t follow, when interest rates go up, generally, bond values go down, and vice versa. That’s not a problem if you are diversified and are in it for the long term. In that case, bonds will redeem at their face value when they mature.

The problem is if you buy the bonds and have to sell them to cover up your cash flow shortfall, then you are likely to lose money. And the banks lost money.

What can we do with our investment strategy to avoid this?

Diversify your risk in a pool of investments from stocks to fixed-income investments and remember to hold some liquid funds or cash as well. This can be further broken down by which type of stocks you own, you can diversify by industry, size of the company, and whether you are investing for dividends or growth.

When you are diversified, you will not run into a problem like a bank did to cover your cash flow problems. You will have another asset pool or cash on the side to cover up and short-term liquidity issues.

Avoid making unrealistic assumptions about the future direction of interest rates or other market factors. By keeping a diversified portfolio, you can weather changes in the market and maintain a balanced investment strategy. No one can predict the future with 100% accuracy, but by taking a diversified approach, you can reduce your risk and increase your chances of success.

Conclusion

In conclusion, recent bank failures remind us of the importance of diversification and realistic assumptions for our investment portfolio. By diversifying your portfolio, you can spread your risk and protect your investments from unexpected losses. Remember to hold some liquid funds or cash as well, so that you can take advantage of investment opportunities when they arise and also have a safety net in case of emergencies or unexpected expenses.

Additionally, it’s crucial to stay informed and up-to-date on market trends and economic indicators that may impact your investments. Don’t rely on assumptions or speculation; instead, conduct thorough research and seek advice from professionals if necessary.

Investing can be a rewarding but also a challenging endeavor. However, by following these key lessons and best practices, you can increase your chances of success and achieve your financial goals while minimizing risks.