Investments

How To Invest In Bank Stocks

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 8 minute read

There’s a reason why finance is one of Wall Street’s favorite industries. It is common knowledge that the growth of financial equities consistently outpaces inflation. Additionally, the industry offers competitive dividends.

Maybe that’s why two of Warren Buffett’s biggest stocks are in the banking and insurance industries. You may be wondering what are financial stocks, what are the benefits and drawbacks of investing in them, and what percentage of your portfolio should be devoted to this field. Find out what it is by reading about it!

How Do Financial Stocks Work?

There is a wide range of businesses that fall under the financial sector umbrella. Businesses in this industry segment include:

  • Commercial and retail financial institutions. Financial institutions such as banks and credit unions provide a variety of lending products, including personal loans, home mortgages, and auto financing, among others. Bank of America (BAC) and Wells Fargo are a couple of the most well-known names in this sector (WFC).
  • Services for Managing Assets and Working with Investors in the Financial Markets. All businesses that help with asset management, such as brokerages and investment banks, are included here. Major players in this area of the financial industry are JPMorgan (JPM) and Morgan Stanley (MS).
  • Banks that issue credit cards. At the time of purchase, customers with a good credit history can access their available credit line from the credit card company, commonly known as the card issuer. Citi (C) and American Express are two of the most well-known brands in this market (AXP).
  • Corporations Working in Financial Technology. In order to simplify your financial life, fintech startups combine finance and technology. Block (SQ), formerly known as Square, and PayPal are two of the most well-known names in the financial technology industry (PYPL).
  • Firms specializing in insurance coverage. When discussing the financial sector, it is appropriate to include insurance providers. A couple of the most widely held insurance stocks are Metlife (MET) and Humana (HUM).

Disadvantages and Advantages of Financial Stocks

Investing in the financial sector comes with its share of pros and cons, just like any other industry. If you’re hoping for market-beating price appreciation, this isn’t the ideal sector to invest in, despite its reputation for steady growth and dividends. The following are some of the most salient advantages and disadvantages of investing in this area.

Advantages

There are a number of benefits to investing in the financial sector, including access to stable growth and dividends at low risk. 

When it comes to financial stocks, some of the most notable benefits include:

  1. Lower Danger. The finance industry is less dangerous than others like the electronics and health care industries. As time has passed, this steadiness has grown increasingly better. Davis Funds claims that, as a result of the lessons gained from the 2008 financial crisis, the largest banks in the United States are hoarding record amounts of cash on their balance sheets. Even stock prices have a tendency to be more steady throughout the industry as a whole.
  2. Profit from Dividends. It’s common knowledge that financial stocks have some of the highest dividend yields. According to Dividend.com, the average dividend yield for the industry was 3.11% as of the middle of 2022.
  3. Consistent expansion even as rates rise. When the Federal Reserve raises the Fed funds rate, banks benefit financially. Given the Federal Reserve’s hints at future rate hikes in response to rising inflation, it would seem prudent to keep an eye on bank stocks.
  4. Continue to grow faster than inflation. Investment returns in the financial industry have historically far outperformed inflation, making them a fantastic inflation hedge.

Disadvantages

There are a number of advantages to investing in the stock market, but there are also some significant disadvantages to think about first.

  1. Income and Expenditures Don’t Show Much Growth. Financial equities often exhibit moderate growth rather than explosive expansion. Stocks in the technology industry are the best chance for growth investors, but there are some promising opportunities in the financial technology industry as well.
  2. Low Fed Funds Rates Impair Long-Term Economic Growth and Reduce Earnings Potential. The Federal Reserve has indicated that it may raise rates in the future, but at this time they remain below 1%. With such a low rate, it is difficult for businesses in the sector, especially financial institutions, to generate profits.
  3. Sad and Uninteresting. To be successful in the market, you need to make smart investments, and that means doing your homework. Finance, unlike fields like technology and biotech, isn’t generally seen as a “hot” profession. Some potential investors may be daunted by the prospect of doing the necessary research to assess financial institutions.

Are Financial Stocks a Good Investment?

Almost any investing portfolio can benefit from holding financial equities. In fact, they are so valuable that even risk-takers who aim to outperform the market often include them in their portfolios. However, some investors won’t benefit from spreading their holdings out among different securities.

If you meet the following criteria, financial stocks may be an excellent investment option for you:

  • You are an Income Investor. The dividends paid by financial companies are consistently among the highest in the market. Investments in some of the most well-established companies in the market typically come with high dividend yields, which is beneficial for income investors.
  • You hate taking chances and always plan ahead. If your risk tolerance is on the lower end, financial stocks could be a good fit for your portfolio. Since 2008, most banks have increased their cash and cash equivalent holdings, making them a formidable player in the financial arena. These companies are also noted for their moderate volatility compared to those in other industries.
  • If you’re anything like me, you need to find a happy medium when it comes to investing. If you are a risk-taking investor with the goal of outperforming the market, you are probably better off putting the bulk of your money elsewhere. However, adding financial equities to your portfolio might help you spread out your investment risk and increase your returns.
  • In other words, you’re just starting out. If you’re just starting out in the financial world, it’s probably best to stick with major, stable corporations that you’re already familiar with. Most banks and other financial entities fall into this category. In fact, buying shares in the bank you already use is frequently a wise first investment. Assuming, of course, that you deal with a major bank.

Which Percentage of Your Portfolio Should Be Committed to Financial Stocks?

The percentage of your portfolio that you should invest in the financial sector is highly influenced by your objectives and risk tolerance. 

How much money you put into financial equities depends on the following factors:

  • Your Aims. You should base your choice of investment strategy heavily on your intended outcomes. The financial industry is a good location to begin investing if you want to achieve moderate, yet meaningful and reliable growth while still generating income from your investments. Put a sizable chunk of your investment capital into companies operating in the sector. When income is less of a priority than capital appreciation, a smaller financial allocation is preferable.
  • Exactly How Much You’re Willing to Take on. There is a lower degree of volatility in financial equities compared to other industries, and these companies are also renowned for keeping a large cash reserve. Because of this, they are safe bets with limited potential for loss. A high proportion of your portfolio invested in financials is appropriate for those with a low to moderate appetite for risk. If your risk tolerance is on the higher end, though, you may want to limit your exposure to this industry.
  • Income from investments is necessary for you. Due to their historically large dividend payouts, financial equities are a popular choice among retirees. If your investment income is critical to your financial well-being, financial equities are a smart choice. If you are a retiree, then you should put a large portion of your portfolio into this industry.
  • It’s important to keep in mind your allotted amount of safe havens. When the stock market drops, you can avoid major losses by putting some of your money into fixed-income assets, gold, or another safe haven. When deciding how to allocate your portfolio’s assets, safe havens should be a top priority.

Pay attention to financial ETFs

There is an alternative to building and managing a stock portfolio on your own if you lack the knowledge and/or time to do so. Money can be invested in exchange-traded funds (ETFs) (ETFs).

Those funds pool money from numerous investors in order to buy shares of stock and other securities in the financial sector. When the value of a company’s stock rises, its shareholder’s benefit. 

To add to this, investors earn dividends proportional to the number of ETF shares they own if and when the stocks in the fund’s portfolio distribute dividends.

The nicest part about financial exchange-traded funds is that they are affordable to use yet are expertly managed by a dedicated team of market veterans. Getting exposure to the financial sector can be done relatively hands-freely with some homework on the top-performing funds in the industry.

The ideal exchange-traded fund (ETF) for your financial portfolio will vary from person to person. The Financial Select SPDR Fund (XLF), Vanguard Financials ETF (VFH), and SPDR S&P Regional Banking ETF are three of the most well-known exchange-traded funds (ETFs) in the financial sector as of late (KRE).

Bottom Line

Stocks in the financial sector are a solid complement to any investment portfolio. The financial industry is a great place to invest if you’re looking for a steady stream of income and like to limit your exposure to risk. 

Financial stocks are a terrific way to diversify your portfolio and provide some much-needed stability if you’re a more risk-taking, growth-oriented investor. It’s easy to see why so many of the world’s most successful investors, including Warren Buffett and George Soros, have a piece of their portfolio in the sector.

When the economy is doing well and interest rates are rising, financial equities often perform well. There was reason to believe that as of mid-2022. There has been an uptick in consumer prices, and the Federal Reserve has signaled that interest rate hikes are on the horizon, both of which are good signs for the bottom lines of financial institutions. This indicates that the financial sector will see future gains.

There is a wide variety of equities available in the financial market. The majority of people just stay the same size forever, while others grow or fall. The returns on investment for some are higher than for others. There are, quite simply, winners and losers. Before putting your money in danger, make sure you’ve done your homework and have a thorough grasp of your investment.

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