When the doors slammed shut to Silicon Valley Bank customers on Friday, thoughts immediately turned to the larger economy. Did this signal a recession? Would it lead to a collapse of banks across the country or world? Did you need to worry about another banking crisis? What did it mean for your own bank account?
A few days later, and most of these questions cannot be answered yet. While other regional banks have struggled, many of the largest banks remain strong. While the banking sector has fallen, there’s already optimism that it will bounce back. And as the S&P 500 continues to drop, inflation and employment numbers remain fairly stable. What do we take from all this conflicting data, arguments and concerns?
It highlights one simple fact: One company or sector doesn’t make up an entire economy. (Nor does the stock market, in reality.) But what occurs when such a surprise failure happens is that we must try and account for the potential contagion of the loss. After all, if SVB fails, could this mean other banks will fail? Or could this crush the venture capital space, an area that SVB serviced? And does this mean that technology companies will soon falter? These could have wide-ranging ripple effects.
Again, the answer to these questions aren’t known. What’s known? If your portfolio was heavily weighted to SVB or financial companies or even startups, then it’s likely struggling more than most right now.
A year before the collapse, SVB’s stock price sat at over $570 a share. If markets knew that a collapse would soon come, they would have escaped the name long before last week. But SVB was considered one of the stronger banks in the space for decades. If you had a heavy collection of SVB, no one would fault you on the name alone.
That’s why this collapse is more of a reminder than a warning. While the economy and markets will determine how deep the failure of SVB will ripple, it’s just another symbol of avoiding concentration in one stock or sector.
Diversify Your Investments
Why? It’s not just because we cannot see a failure coming (in most cases), but due to the fact no one can tell you who will outperform and why on a regular basis. Take the S&P 500, or the group of the 500 largest companies in the US. Overtime, nearly all of these companies, as a group, perform about as well as your cash in a bank account. Very few move far ahead, while others underperform.
How, then, does the S&P 500 outperform over many years? Because a few companies in the market account for much of the gains. In 2021, for example, five companies accounted for 31% of the S&P 500 annual return of 28.5%. In 2020, the top five accounted for 62% of the 18.5% increase that year. You have to have access to these by moving into them before they move forward to enjoy it.
Meanwhile, if you try to pick a few names and you’re wrong, you could find that your money barely moves or that’s in one of the underperforming companies. Worse yet, you might have overcommitted to a company like SVB.
Having all the eggs in one basket will prevent you from realizing long-term investing goals. While the world works out the SVB fiasco, it’s important to use this opportunity as a reminder that it’s better to invest in the market as a whole rather than pin your hopes to one area.
It’ll leave you a lot safer and less worried when poor management derails another company. If we have learned anything over history, it’s that SVB won’t be the last seemingly thriving company to fail.