Exposed: The banks might be too big to fail but in the event of a crash only the depositors are protected, not the shareholders. Photo: illustration Chris Pearce
Australian bank stocks have been good to sharemarket investors. So good that some – including many who might consider themselves risk-averse – have simply astonishing amounts invested in them. Some Intelligent Investor Share Advisor members have disclosed that big banks constitute 40 per cent of their portfolio.
It's especially worrying because bank stocks are masquerading as the market's miracle-makers but are far riskier than most investors appreciate.
The solution is simple: sell down your bank holdings so that they're no more than 20 per cent of your portfolio. There's no need to sell all at once; indeed you might pay less capital gains tax by staggering your sales over a few financial years, although that means waiting to sell a second parcel until next July.
Either way, it's time to get serious. If you're having trouble reducing your portfolio exposure to the banks, think carefully about your justifications for holding. For example, have you heard yourself say any of the following?
Banks have been fantastic investments – why would I sell? It's the future that matters and in the banking sector at least there are more risks now than there have been for a long time.
Bank stocks might keep going up. Nobody wants to miss out on an even larger capital gain. But regret aversion – the fear you might be wrong – often results in a lack of action. Weigh up the risks, make a decision and resolve to accept it.
Banks look cheaper than other stocks. Bank price-earnings ratios are traditionally 10 per cent-25 per cent lower than the market average because they're more risky. Owning a bank is a bit like taking out a mortgage for 95 per cent of the value of your house, then re-borrowing the increase in value each year – fine while house prices are rising but not so great when they fall.
Bank stocks have high yields and I need income to live. Higher yield implies higher risk. Even during the GFC – from which Australian banks emerged unscathed – dividends were cut by about 25 per cent. A local recession could result in capital raisings and a permanent reduction in dividends.
Australia's economy is strong. Australia has avoided a recession for 23 years, so it's no wonder banks have prospered. But they suffer enormously during economic downturns. Remember how 22 years ago Westpac came close to collapse after writing off $2.7 billion in bad debts? It can happen.
Australian banks are too big to fail. True, but a government rescue would protect depositors, not shareholders. Between 2007 and 2009, the share prices of major British, American, Irish and Icelandic banks fell by more than 90 per cent before they were nationalised.
What else would I buy? There are 21 stocks on our Buy list and our model portfolios have outperformed the market with negligible exposure to banks. Dedicating a large chunk of your portfolio to the banks isn't a risk you need to take. You don't have to reinvest any sale proceeds immediately; better to wait patiently for the right opportunity. The capital gains tax bill will be too large. Australia has had a capital gains tax since 1985. A portion of your gains has always belonged to the government. Paying tax is the mark of a successful investment.
That said, there are ways to minimise the capital gains tax you'll pay on share sales. Making tax-deductible superannuation contributions might be one way. If you own your bank shares in a superannuation fund, converting it to an allocated pension is another.
A simpler strategy is to stagger your sales over two (or more) financial years. This strategy, which mainly for those on low-to-average marginal tax rates, takes advantage of the 50 per cent capital gains tax discount applicable to investments held for more than a year in an individual's name.
Unless your income is well under the tax-free threshold of $18,200 a year, you will pay some capital gains tax on the sale proceeds. But, depending on your income – and you should calculate how any sale proceeds might affect your marginal rate – the tax won't be particularly onerous for many shareholders.
While we're by no means predicting a banking crisis, the events of five years ago show it can happen. Statues might belong on pedestals but banks certainly don't. Both can be toppled by tremors, so taking precautions is wise.
A sensible portfolio weighting to Australian banks of no more than 20 per cent will help you ride out any shakeout. Sell your bank holdings down now to keep your portfolio on a solid footing.
Nathan Bell is research director of Intelligent Investor Share Advisor (AFSL 282288). To unlock all of Share Advisor's stock research and buy recommendations, take out a 15-day free membership.