Making Money with Banks and Insurance Stocks

In this section, you’ll…

• Learn what drives profits for banks and insurance companies
• Understand how increasing diversification makes financial institutions safer investments
• Learn why financial companies are good long-term investments
• Find out why lower interest rates means higher financial stock prices

A key sector that should be part of any portfolio is the financial industry.

You’re probably sick and tired of hearing about the impact of baby boomers. However, they certainly make the financial sector a good long-term bet.

In addition to traditional lending, financial institutions have rapidly moved into investment banking, wealth management, and brokerage services to serve this powerful and profitable population group.

Their increased breadth of businesses makes them a great long-term play for investors since dependency on any one source of revenue and vulnerability to a single business downturn diminishes.

One last thing to remember about financial service companies is this: falling interest rates mean rising profits (and share prices) for financial institutions. Conversely, their stock prices falter when rates are rising.

With the Federal Reserve’s tempering of interest rates over the last few years, we’ve seen this scenario occur first-hand by how the financial stocks have benefited.

There are several reasons financial stocks respond well to falling interest rates. Financial institutions do more business when interest rates are lower.

When rates are high, it’s hard, for example, for businesses to justify borrowing money to expand. Also, loan defaults and late payments decrease, as rates drop. Lower interest rates also help raise the value of fixed-income investments owned by financial institutions

Interest rates directly affect the credit market (loans) because higher interest rates make borrowing more costly.

Our First Financial Stock

Let’s take American International Group, or AIG for instance.

• At a market cap of around $57.53 billion, it is one of the world’s largest financial institutions.
• It operates all over the world. This means an economic slowdown in any one country won’t take the whole company with it.
• It is involved in many different areas and sectors of the insurance business.
• It has multiple sources of revenues from financial services and its asset management business. Again, this adds to its diversification.

A financial company that offers a wide range of services to its clients is referred to as a ‘Financial Supermarket’.  Citibank is an example of a financial supermarket by allowing you to do your banking, trade stocks, or purchase mutual funds and insurance.

Buy Yourself a Big Bank

Let’s now take  Barclays – a bank…and a whole lot more.

Barclays is one of the biggest financial companies around. Its market capitalization is around GBP34.72bn billion. It provides services to businesses and individuals, and it operates in a number of countries. In addition to traditional consumer and corporate banking, the company is also involved in investment banking, as well as international wealth management.

Let’s now look at two more sectors; the Utilities and the Energy sectors.

Key Learning Points

• Financial stocks tend to be cyclical. Their prices tend to rise when interest rates are falling, and fall when interest rates are rising.
• The increased breadth of businesses financial institutions are becoming involved in helps make them a great long-term play. As a result, they are less dependant on any one source of revenue and less vulnerable to a downturn in any one particular line of business.
• There are several reasons financial stocks respond well to falling interest rates. Financial institutions do more business when interest rates are lower. When rates are high, it’s hard, for example, for businesses to justify borrowing money to expand. Also, loan defaults and late payments decrease, as rates drop. Lower interest rates also help raise the value of fixed-income investments owned by financial institutions.