Mistrust toward banks and other financial institutions prompts more fearful individuals to seek alternative venues to park their capital. Others may be avoiding the banks on principle, given their participation in the reckless lending that led up to the housing bubble bursting and triggered the Great Recession.
Of course, after last year's wildly volatile stock market, banks have started looking safer. But all the same, it's worth looking at these seven alternatives. One, in particular, is considered the safest place to keep cash.
- The FDIC protection for deposits makes banks look appealing in difficult times, but there are alternative places to put money.
- Federal bonds are considered very safe but have very low returns.
- Real estate can produce income but can be risky.
- Precious metals, especially gold, offer an alternative to stocks and bonds.
- Luxury assets are tangible, but lag stock market returns.
- Hidden cash isn’t secure and loses value over time because of inflation.
- Businesses are another place to put money, including farms.
- Cryptocurrency is a new alternative but comes with its own risks.
Where Do Banks Invest Their Money?
Banks offer their customers a place to stash their cash safely for a modest return in interest. In turn, the banks invest that cash, aiming for higher returns. First and foremost, they lend it out to businesses and consumers as loans, making a profit from the interest payments. They also make money on the fees they charge their customers for various services.
In addition, banks invest a portion of their money directly in assets such as real estate, bonds, and stocks.
Note that today's banking giants have investment banking divisions as well as commercial banking services. That's a whole separate revenue stream that involves financial management and consulting services for corporations and wealthy individuals.
Why Keep Money Outside of the Bank?
The website for the Federal Deposit Insurance Corporation (FDIC) states that "no depositor has ever lost a penny of insured deposits since the FDIC was created in 1933." But FDIC insurance only covers "$250,000 per depositor, per FDIC-insured bank, per ownership category." This applies to both the initial principal and any interest earned.
Meanwhile, investments in the S&P 500 Index have yielded an average return of about 8% over the past 60 years. But the long-term record for solid returns in the stock markets is dotted with downturns that shake the confidence of some investors. Most stock indexes dropped by 4% to 6% overall in 2018, for example. That was the worst record in 10 years until we got to the market drops triggered by the economic crisis.
If you're still looking for alternative places to park your money, here are seven possibilities:
Investments in stocks and bonds are not covered by the FDIC.
1. Federal Bonds
The U.S. Treasury and Federal Reserve would be more than happy to take your funds and issue you securities in return, and a very safe one at that. A U.S. government bond still qualifies in most textbooks as a risk-free security.
Unfortunately, many individuals and institutions already know that and have entered the bond market ahead of you, which has bid bond rates to very low levels in this time of crisis. On April 9, 2020, the yield from a 10-Year Treasury Note was 0.73%, an all-time low. If the low rates don't deter you, government bonds are one of the safest places to keep cash.
2. Real Estate
In disquieting times for the banks and the stock market, the allure of real estate investment can be strong. Become a landlord. Put down some of your principal on a property, fix it up a bit, rent it out, and have your tenants pay off the mortgage. Or, if you're interested in a shorter-term opportunity and have more experience, maybe try flipping houses.
Done right, real estate can have a huge financial upside. Yet it can also be a risky and sometimes fickle investment. True, residential and diversified real estate investments have averaged about a 10% return in the past 20 years, which is slightly better than the S&P 500 in that period. But real estate can also be an unreliable investment, especially in the short term.
An extreme example is the housing bubble that burst and led to the Great Recession. The global economic downturn that began in 2007 resulted in millions of people losing their jobs and homes, resulting in a housing market crash.
It's unclear how the current economic situation will ultimately affect the value of real estate. The huge hit to the economy and employment will likely limit buyer's ability to come up with cash and desire to part with it.
On the other hand, sellers who really need to sell may be willing to settle for lower prices. And relocations due to people who started working from home leaving cramped, expensive center-city housing have helped suburban and exurban regions in some parts of the country while lowering values in some cities.
3. Precious Metals
One doomsday scenario in which financial markets cease to function holds that gold, silver, and other metals such as platinum or copper will continue to retain their value, if not appreciate.
The likelihood of having to return to a barter system with physical goods is minimal, but it may make sense to hold a certain percentage of your assets in this form. For one, precious metals have historically provided a low or negative correlation to other asset classes like stocks and bonds—which is to say, when those investments go south, metals are unlikely to follow, at least very far, and may even increase in value.
4. Luxury Assets
This category of tangible assets encompasses fine art, cars, watches, diamonds, and other jewels, and just about anything that qualifies as a collectible. In their favor, they're objects that can be touched and seen, compared to a bank account statement that could take time to collect on if the financial institution that housed it ceases to exist.
That said, luxe investments are hardly a sure bet. While data on their historical returns are elusive, they are generally thought to have lagged stock market returns, while having periods of rapid appreciation due to either strong financial market performance or periods of popularity, which increases underlying demand and resulting prices.
5. Cash, Hidden Away
Although stuffing money under your mattress has become a cliché, it unquestionably keeps your funds close at hand, if not necessarily secure. You could, of course, also hide your assets in a safe deposit box or safe.
Again, this method probably qualifies only for a doomsday scenario, or for times of a short-term liquidity crunch. Even then, keep only a small stash, not least because inflation steadily erodes the value of currency over time. In a deflation, the opposite is true, of course.
Cash held in a safe deposit box is not insured.
6. In a Business, Perhaps a Farm?
Buying a business can ensure a return on your investment, provided of course that the enterprise generates a profit. In very bad times, of course, businesses suffer as well. A farm can be a particularly tangible business, if not a reliably profitable one.
You don't necessarily need to get our hands dirty, either; with a so-called investment farm, you hire staff to handle the actual agricultural operations. Owning farmland is a good fit with a survivalist mindset, too, since the land can produce food on the off-chance of a global calamity or meltdown of the global financial system.
Cryptocurrencies are another alternative investment option. There are a number of choices; Bitcoin is just the best known. So-called "cryptos" offer individual investors a unique opportunity to get into what is still very much an emerging technology.
Of course, this is also a high-risk, high-reward opportunity. For example, after soaring to stratospheric highs, bitcoin lost about three-quarters of its value in 2018. You shouldn't invest much, or any, funds in cryptocurrency that you'll rely on for your future. Yet most analysts believe these alternative currencies are here to stay and brave investors may want to pitch a stake on the off-chance of hitting it big with one of them.
The Bottom Line
Although the subprime mortgage meltdown is more than a decade old, the financial industry is still looked upon with some suspicion these days, at least by some skeptics. And the stock market may be no less of a concern for such people, particularly in the wake of the unprecedented ongoing volatility the markets have experienced.
For the especially wary, the above alternatives to a traditional bank or stocks may make sense for at least a percentage of net worth. But given their risk, none should be too big a component of your investments.