If you want to play with the big dogs, you have to understand how they invest their money. If you can bank on any industry or company to make it out of a recession and make boatloads of money while acting like they have your best interest at heart, then look no further than the banking system.
So, if the banks are always going to make money, why don’t we just invest in what they put their money into to guarantee a return? Well, it’s not as easy as it sounds, but I’m going to try to show you where the banks get all their money from.
Introduction to Banks’ Investment Practices: Understanding the Purpose and Importance
So, if you’re looking at me thinking, ‘I didn’t know banks invested their money, I thought they just used the money that we give them to pay bills and do whatever,’ well, that’s wrong. Banks actually make a lot of money by investing their money in other corporations and companies, just like any other corporations and companies do.
When banks invest their money, they generate profits, provide liquidity for you to withdraw your money, and it helps them manage risk. When you put your money in a savings account and they give you a half percent yearly return on your money, they’re actually taking your money and investing it, hoping that you won’t withdraw all of it. They simply give you a small portion of the returns they earn. Doesn’t seem fair, right?
Types of Investments Banks Engage In: Loans, Securities, and More
Maybe you’re wondering what exactly do they put their money into. Well, banks make a lot of their money from loans, securities, and straight investing. When it comes to loans, it doesn’t necessarily mean them handing you a lump sum of payment. It could be if you overdraft your account, charge too much on your credit card and can’t pay it back, or if you can’t pay your bills such as your mortgage or car payment.
From a security standpoint, banks invest their money in government bonds, corporate bonds, and other kinds of fixed-income instruments. We have discussed this matter in previous blogs. On the other hand, banks also invest their money in real estate or even the stock market; nothing is off-limits for them.
The Role of Risk Management in Banks’ Investment Strategies
Now that we understand how banks invest their money, we need to take a deeper dive to see what kind of strategies they use to ensure they have enough money to cover everyday expenses, as well as accommodate people who withdraw their money daily.
Recently, you may have seen how bigger banks have gone under due to ‘poor management,’ which essentially means they were too greedy and didn’t properly monitor the risk they posed to their clients. One thing that banks do is ensure that whoever they loan money to is able to repay it, and that’s where your credit score comes into play. If the stock market is performing poorly, they will invest more in real estate. If real estate is doing poorly, they will invest more in the stock market. And if both are performing badly, they can invest more in government and corporate bonds. It’s a win-win situation for them.
Diversification: Why Banks Spread Their Investments Across Various Asset Classes
I’ve touched on diversification a couple of times earlier, but it’s no different from how banks invest billions of dollars compared to you investing a couple of thousand. You don’t want to have all your eggs in one basket, and diversification also helps reduce the risk of losing all your money if you have a diversified portfolio. Banks will even invest in other countries’ currencies, just in case things go wrong with their home currency. Minimizing losses and maximizing gains is the key to consistency.
Real Estate Investments: How Banks Leverage Property for Long-Term Returns
I think this topic was big enough that it deserved its own paragraph because banks heavily invest in the real estate market. They acquire properties under different names and rent them out to people, while also earning money from mortgage payments that they collect.
When banks give out a mortgage loan, they are guaranteed to receive that money back with interest over 15 or 30 years. If they don’t get the money back, they can foreclose on the home and acquire the property. In most cases, they can sell it and still make a little profit. That’s why real estate is one of the top investment vehicles for many people.
