It is entirely possible for them to safely promise a 3% account under these conditions. This is not at all like the financial crisis. It's just wrapping an investment grade bond fund in a bank account interface.
This is extremely misleading and no one should be using bond funds as a checking/savings account replacement. You have mark to market and liquidity risk here which in normal circumstances you do not have with a savings/checking account.
Additionally, Robinhood is reportedly investing proceeds in US Treasuries. US Treasuries have a completely different risk profile than corporate investment grade bonds.
With the important difference that money market accounts should never lose principle (aka "breaking the buck"). It has happened, but its fairly uncommon.
Bond funds, however, frequently can and do lose value - if interest goes up, price goes down (the reverse should also be true, though).
When you buy a bond and the interest rate goes up, the nominal value of the debt goes down when the interest rate goes up, while with bank accounts they stay the same.
Ex: You buy a $100 bond at %3, then the prime rate goes up %1 so the typical market price of bonds of your class are now %4. Now your bond is worth less than $100 if you were to liquidate it.
However, in this case, won't it be more like a bond-fund, where the fund essentially has a ladder of bonds that are constantly expiring and getting reinvested (and also investing new investments from retail investors), and so the overall value of the fund may still remain close to $100.
I could well be wrong, so please feel free to correct me! Trying to learn.
Yes bond funds do that to even out interest rate changes kindof, but those fund prices can still go up and down in price as a result of interest rate changes and other market dynamics.
If they called this the 'bond fund account' with easy liquidation and buying to make it bank account-ish, then I don't think people would be as upset about this, but it would be a fairly niche financial product.
There is a strong difference between Yield to Maturity and effective yield. Yes, If they hold bonds until they mature, specifically government bonds, there will be no loss in principle.
What people seem to be misunderstanding is that a yield curve exists. If they were to go the safe route of short maturities, the interest rates will be must lower than long dated securities. If they reach for yield in longer term securities, they will have to mark to market when interest rates rise (which they most likely will due to the fed signaling that they'll be tightening in 2019).
One risk is that the other investors might suddenly decide for some reason (say a sudden wave of panic) to cash out their holdings in the fund. This would force the fund manager to immediately sell some of the bonds, perhaps at an unfavorable price. Bonds (safe ones) eventually pay out at their full value, but their market price fluctuates before maturity, and a sale forced by other investors could stick you with a loss.
But it carries more risk. It may not continue to pay 3%. In a financial crisis the money may not be there any more, the companies may go bankrupt en masse for example, or companies that were previously thought to be safe may not be able to meet their obligations. There is no sort of guarantee here, and the SIPC guarantees are supposed to be about making sure investors end up with the securities they purchased, not making investors whole if their investments turn out to be worthless.
It is precisely this kind of bundled 'derisked' derivatives which caused the last financial crisis (those were sold as very low risk mortgage debt , these are corporate debt).
It may be fairly safe, but it's not risk-free (and certainly not guaranteed by the government). Even if companies don't default, their borrowing rates can still increase, reducing the value of the bond and causing you to lose money.
The 3% return is compensation for the added risk. The financial markets are pretty efficient for liquid stuff like this.
Banks also provide services that consumers are willing pay for through lower rates on their checking accounts, and need to cover their administrative costs or have some other way of making money with the deposits.
It's very unlikely that regulators and smart money would smile upon "wrapping" VCSH or similar corporate bond fund and trying to transform it thereby into a demand deposit account.
A bond fund like that, even with a relatively short duration of 2.65, is going to have significant price movement in the principal amount due to interest rate risk. (Not counting credit risk etc -- credit spreads could move significantly too in a financial crisis.)
A big rate move coupled with a big jump in credit spreads could easily move the price of the underlying by several percent in a matter of days.
Not so cool when your deposit of $100 can only be cashed out for $97 a few days later.
This is an important distinction. When the money marketeer redeems a dollar for less than a dollar it "Breaks the Buck" [0]. Cowen's MM account IIRC was the first one to do that back during the 01 crash.
Yeah. And the haircut is usually quite small. If I sold my money market for 98 cents on the dollar in a financial crisis I really wouldn't be that upset.
Look at the "SEC yield." That's what it pays going forward. Returns were lower over the past five years because the Fed had lowered rates to stimulate the economy.
The yield is only part of the return, one has to consider also the change in price. If interest rates go up prices will go down and the actual return will be lower than the yield.
Over the last 12 months, the price of the VCSH fund is down more than 2%. This offsets the dividends paid with the coupons received and results in flat performance.
Yes. This is a marketing website for Vanguard, so of course they want to list the highest return possible, and dividends definitely do count in performance.
For what it's worth, the point of deposit insurance is not to mitigate against typical situations where bonds behave "like normal" and stick to their typical default rate. The FDIC and SIPC were founded in response to what happens when everyone just turns a blind eye and says "oh, that's totally safe, risk is _near_ zero!"
Well, we're in a strong economy so of course the default rate will be near-zero. What happens if there is a financial or economic crisis and companies start defaulting?
Vanguard is not a corporation. It is structured as a mutual company; it is owned by funds managed by the company, and is therefore owned by its customers.
Vanguard has many pieces and parts, many of which are, indeed, corporations. It says so on the bottom of its website: "Vanguard funds not held in a brokerage account are held by The Vanguard Group, Inc., and are not protected by SIPC. Brokerage assets are held by Vanguard Brokerage Services, a division of Vanguard Marketing Corporation, member FINRA and SIPC."
Regardless of its legal structure, I meant "megacorp" in the generic sense of "large company."
https://investor.vanguard.com/etf/profile/VCSH
It is entirely possible for them to safely promise a 3% account under these conditions. This is not at all like the financial crisis. It's just wrapping an investment grade bond fund in a bank account interface.