As I write this article, the latest crisis du jour is the collapse and insolvency of the Silicon Valley Bank.
We here in Canada tend to think of our banks as being virtually invulnerable. But as the 2008 banking crisis taught us, even the biggest blue-chip companies still face their own risks. This is especially true with smaller niche banks south of the border, where the regulatory environment is very different from the one that governs our own banking industry.
That said, given all the press surrounding the collapse of Silicon Valley Bank, you could be forgiven for wondering if your bank is in danger of becoming the next domino to fall. The good news is, while the SVB crisis is certainly concerning, it’s highly unlikely that something similar will happen here. The better news is, whatever does happen, there are three simple steps you can take right now to help make sure your retirement portfolio is effectively crash-proof.
What exactly is going on with Silicon Valley Bank?
To put things in the simplest possible terms, the way banks make money is by leveraging the funds their clients deposit with them. When you deposit money in your chequing or savings account, your bank will typically lend some multiple of those funds out to borrowers in the form of mortgages, lines of credit, or personal and business loans. The bank charges interest on those loans, and then pays you a tiny fraction of that interest (if any) for the pleasure of holding onto your money for you.
This all works well – unless those depositors decide they all want their money back at the exact same time. When this happens, the bank can’t pull in enough of its long-term loans to cover all the withdrawal requests, which leads to even more panicked depositors trying to get their money out. This is called a “run on the bank,” and if the avalanche of withdrawal requests gets bad enough, the fear starts to feed on itself in a downward spiral until the bank either gets bailed out, bought out, or simply collapses.
Is my bank about to go bust?
Thankfully for Canadian investors, the odds of the Silicon Valley Bank debacle happening here anytime soon are almost vanishingly small. For one thing, due to the more stringent regulations Canadian banks must adhere to, they tend to be more resilient than most other banking systems around the world.
In addition, even what’s going on now with American banks like Silicon Valley – which is mainly a result of their bond portfolios being negatively affected by rising interest rates – is still very different from the widespread credit default swaps and dubious, toxic asset–backed paper schemes that led to the global financial crisis of 2008.
But I’m not here to reassure you about the health of banks. Whether it’s the banking system, political turmoil, the effect of rising rates or a plunge in tech stocks, there’s always going to be some crisis or other hanging over the markets. So for the average investor, a better question to ask yourself isn’t which new crisis is going to impact the markets tomorrow, but what you can do today to make sure your portfolio – and your retirement income – are ready to weather whatever storm might come along?
3 steps to protect your portfolio before the bad news happens
One way to escape the inevitable ups and downs in the market is to simply pull your money out of equities, put it all in GICs (or under your mattress), and then watch as taxes and inflation slowly chisel away at its value year after year. You could also consider putting your life savings into gold, fine art, cryptocurrency or NFTs. But as very recent history has shown us, each of these theoretical escapes from the market gyrations comes with its own set of potentially disastrous risks.
The fact of the matter is, over the long term, almost nothing offers a more reliable return on your investment than a broadly diversified stock portfolio. Luckily, for those of us who are invested in equities and approaching (or at) retirement age, there are three big things you can do right now to protect your nest egg – and your retirement income – from almost any potential pitfall.
Step 1: Have 3 years of income stashed away
First, make sure you have enough money to cover at least three years of the income you’ll need from your portfolio tucked away in something that won’t get hurt by market swings. Think ultra-safe investments like government bonds, cash or GICs.
Why three years? Because historically, the average bear market lasts around 18 months. Having three years of income stashed away will let you go twice that long without needing to cash out any portion of your portfolio at a loss, and likely give your assets enough time to cycle back up to their previous peak before you need to draw on them.
Step 2: Don’t lose your cool
Second, try not to lose your head when a market correction does occur. Too many people make the mistake of rushing to cash out right after the market drops, with the idea of waiting on the sidelines until things look better.
Unfortunately, even a single round-trip ticket to this kind of selling low and buying high can put a major dent in your net worth. A couple round trips like this could seriously compromise your financial future, and might even jeopardize your retirement.
Step 3: Pick up some bargains
Lastly, instead of joining the crowd on its headlong dive into panic selling, remember that every up- or downswing in the markets is part of a cycle, not a permanent trend. If you’re in a position to be able to take advantage of them, market corrections can actually be a great time to pick up a few bargains.
During the COVID-inspired correction of 2020, for example, stocks went down by about 40 per cent in value. At the time, we had no idea what the future might bring. But what we did know was that preferred shares dropped even more than the average stock.
Preferred shares, as their name suggests, have a preferred claim on assets and cash flows relative to common stocks, so they’re technically safer. Yet in 2020, preferred shares dropped by almost 50 per cent while the riskier regular stocks went down by much less.
By staying calm and switching part of our clients’ portfolios to preferred shares, we were able to dramatically increase their income (in many cases to a higher level than they had before the correction) while also preserving their ability to recover the full value of their portfolios once the panic subsided.
Stay calm and carry on
Don’t get me wrong, this isn’t an ad for preferred shares, any more than it is an endorsement of bank stocks. Preferred shares may or may not be the answer for the next downturn. But two things are for sure.
First, there will be another downturn at some point. Second, if you have a reserve of cash stashed away, and if you can stay calm and keep your head while others around you are losing theirs, then there will almost certainly be a way through it that lets you maintain – or maybe even increase – your retirement income.
This article is supplied by Alan MacDonald, an investment advisor with RBC Dominion Securities Inc. Member–Canadian Investor Protection Fund.