Do you have financial stocks in your portfolio? Here’s why you should – and why you shouldn’t.
Financial stocks may bring a lot of things to mind for an investor. Perhaps you picture yourself in a gleaming, marble lobby of an ornate bank building. Maybe it’s a corporate boardroom discussing lending rates, revenue, and buyouts. Or maybe it’s Jimmy Stewart as a banker in “It’s a Wonderful Life” explaining how banks invest money.
In a way, financial stocks are all that, and much more. For example, Financial Select Sector SPDR ETF (XLF) includes holdings in all six of the biggest U.S. banks, including JP Morgan Chase (JPM), Bank of America Corp. (BAC), Wells Fargo (WFC), and Citigroup (C). But other financial stocks take the form of online brokers like TD Ameritrade (AMTD)and E*Trade (ETFC), as well as insurance companies.
The ups and downs of financial stocks
A strong economy will generally boost financial stocks, and commercial and industrial loan growth benefits certain bank stocks. Furthermore, when interest rates are rising (at least in the short-term), interest margins expand, which adds to income. And rising rates usually mean the economic picture is improving, thus boosting loan growth—and income.
For investors, most banks pay at least a 1% dividend yield, so you get cash while you wait for appreciation. What’s interesting, however, is that while you might expect more profits from the big names, regional banks tend to be well-run in many respects, little cash cows, and often attract interest—and buyout offers—from the large banks who are seeking to expand in their markets. And when that happens, the bank being acquired often sees its stock rise to premium levels—a great selling point for its shareholders.
As well, regional banks generally pay a decent dividend—somewhere between 2% and 4% on average. And that helps boost your return, while you wait for the shares to rise.
It’s important to note, too, that there is a lot of chatter around regulation and deregulation at any given time. While “deregulation” sounds suspiciously like “removing rules that control banks,” in our context, it mostly means “removing layers upon layers of duplicate government reporting that costs banks a fortune.”
The less money a bank spends on attorneys and staff to fill out duplicate government reports and their associated duplicate fees, the more money they get to keep for pro-business activities such as new hires and new services. Those pro-business activities in turn generate higher profits, and increased U.S. government income tax revenue from both corporations and new employees
That said, regulation and deregulation, and really almost any similar news can lead to a a dizzying ride in the world of financial stocks. For instance, from early November 2017 to March 1, 2018, the Financial Select Sector SPDR ETF (XLF) soared more than 26%, topping 25 for the first time in more than five years. Then in the first week of March, the ETF closed below 23 for the first time in over two years despite a couple of strong first-quarter earnings reports from the big banks. Bank stocks went on to fall more than 9% in over the next six weeks, at a time when the S&P 500 had dipped only 2.8%.
To learn more about financial stocks and how to find the right ones for your portfolio, download our free report, The Five Best Dividend Stocks to Buy Today.
What do you find most confounding about financial stocks? Let us know in the comments below.