As the past year has shown, rising interest rates can be bad news for the stock markets. However, some bank stocks have resisted the downward trend.
Why? It is all about the various types of bank stocks and the pros and cons to investing in them.
What are bank stocks?
Bank stocks are fractional shares that financial institutions hold or lend money. Bank stocks can be classified in a variety of ways, depending on their size or core business.
>> For more information, see our primers on stocks and banks
National, community and regional banks
National banks have assets of more than $100 trillion and are often located throughout the United States.
The assets of range from $10 billion to $100 billion. They may also limit their operations to certain states and other geographical areas.
The assets of community banks are less than $10 billion. They may operate in one metro area or one part of a state.
Investment, retail and commercial banks
Publicly traded companies and governments can use investment banks. They offer wealth management services and assistance with mergers and initial public offerings (IPOs). Their performance is often linked to the stock exchange.
Smaller businesses can be served by commercial banks. They offer loans and business accounts. Their performance is often related to interest rates (higher rates may mean greater profit margins on loans) and the strength of the economy.
Retail banks offer services to individuals such as checking and saving accounts, credit cards, and financial advice. Their performance is dependent on economic conditions and interest rates, much like commercial banks.
Sometimes, the lines between these two categories blur. Many large national banks, including JPMorgan Chase and Bank of America, have investment banking, retail banking and commercial banking divisions.
The best bank stocks based on one-year performance
Below is a listing of 25 bank stocks that have performed well on major U.S. stock markets. It has been sorted by their one-year performance.
Stock data can be delayed. It is meant for informational purposes only and not for trading.
The pros and cons of investing bank stocks
As interest rates rise and stock market indexes drop, bank stocks like the one shown above might be attractive. It is important to realize that each stock has unique upsides and downsides.
Higher interest rates are preferred by retail and commercial banks. Noninvestment banks borrow the majority of their money. Higher interest rates translate into more income from lending.
Stability: Investment banks tend be large blue-chip businesses, while retail and commercial banks are subject to deposit insurance and reserve requirements from the government. Although banks can experience downturns, and sometimes even go out-of-business, they are generally more stable than technology stocks.
Most banks pay dividends. Dividends are a sign of financial health and the vast majority pay them consistently.
Cons of bank stock
Values: Bank stocks might not be the best option for those who want to invest in companies that reflect their values. Banks, particularly large ones, often count fossil fuel and gun companies as clients. They have been involved in money laundering and sanctions evasion at an international level.
Bear markets are not a favorite of investment banks: Largely, publicly traded companies serve big investment banks. This means that they are able to do well when the market is performing well. Companies tend to tighten their belts when times are difficult, such as now. This means that investment banks will see a decrease in revenue.
Risks to regulatory compliance: The Dodd-Frank Wall Street Reform and Consumer Protection Act was passed by Congress in 2008 after the financial crisis. This law gives the Federal Reserve the power to limit bank stock dividend growth and share buybacks during financial stress. These restrictions were imposed by the Fed during the 2020 recession.
How do I buy bank stocks
If you are new to investing or you want to buy bank stocks, you should open a brokerage account.
Individual bank stock
The shares of certain banks can make money: Many of the bank stocks in the above list have outperformed S&P 500 by large margins over the past year.
However, individual stock investments can be very risky. You could lose a lot of money if you invest a large portion of your portfolio in individual stock stocks of banks.
If you are adding multiple stocks to your portfolio, buying individual stocks can have a high upfront cost.
Experts suggest that you can reduce these risks by keeping individual stocks under 10% of your overall portfolio and carefully researching stocks before purchasing them.
Another option is to purchase dozens of bank stocks through an ETF. These ETFs offer diversification and are often cheaper than individual shares of the banks they contain.
There are many types of bank ETFs available to suit different segments of the banking sector.
Financial sector ETFs are a great way to get exposure to banks that have investment banking operations. They largely include large Wall Street firms. Regional bank ETFs are a good option if you want to be exposed to retail and commercial banks in your region.
The editor and author were not involved in any of the above investments at the time that the article was published.