The recent collapse of Silicon Valley Bank (SVB) has many lessons for investors. A direct lesson is to ensure that your cash is deposited in a bank with a solid foundation and is adequately protected by the FDIC insurance. See an article here on how the FDIC insurance works when a bank declares bankruptcy. A second direct lesson is to avoid reaching out for yield and depositing your cash in banks that offer a high interest rate without doing your due diligence.
In addition, the operations of the bank and its eventual demise have several lessons for investors:
The importance of diversification: SVB did not diversify its assets or its liabilities. It predominantly worked with Silicon Valley startups and venture capital firms and grew remarkably during the pandemic when these firms were flush with cash and deposited large amounts of money. It invested a vast majority of these deposits and primarily invested in longer term US treasury securities.
The need to invest based on your objectives and not based solely on the attractiveness of the asset class: The long-term US treasuries that SVB bought were very sound investments with almost zero probability of loss through maturity. However, they were not a suitable match for their liabilities i.e. the deposits by the kinds of depositors that SVB worked with, who as it turns out, had a much shorter duration than the US Treasuries the bank bought.
The importance of time in any investment decision: In investing, time is the most underappreciated factor of investment success and so it was with SVB. Long term US treasuries are a very safe asset class but only if they are held to maturity. Before maturity, their performance depends on the time to maturity especially when interest rates are rising.
Not understanding different kinds of risk: Long term US treasuries have the full faith and credit of the US Government. This is why they are often called ‘risk free’ assets. Risk in this context is credit risk i.e the risk of default by the borrower (The US Government). However, long term US treasuries have non-negligible and material interest rate risk, that is the sensitivity of these instruments to the direction of interest rates. While the bank was lulled into complacency by the negligible credit risk, it was blindsided by the considerable interest rate risk that the asset class posed.