Truth be told, it took me a very long time to realize that banks are a tool that will help me achieve my personal finance goals. Every three months, the Big Banks release their earnings. More often than not, those earnings are in the billions, if not the hundreds of millions. And people start frothing with anger at the size of those quarterly earnings. Ink is spilled all over the Internet about how banks are evil and their earnings are obscene.
Two days later, the angry mob has moved on to some other topic upon which to unleash their rage. The banks go back to the business of earning more money so they can hit their next quarterly target.
And I wonder to myself if any one person in the mob realized that banks are a tool?
How banks make money
First off, I want to be very clear that I’m not an expert on the banking industry. I’m just an online citizen who has watched banks operate for the past 35+ years. I even used to work as a bank teller, which was an incredibly educational experience. However, being a bank teller and being a banking expert are two wildly different things.
I’ll share with you what I know.
Banks take money from depositors then lend it to borrowers to earn money. This is the heart of banking. Everything else is a detail.
Depositors have bank accounts and they expect to earn interest on their deposits. As we all know, most bank accounts pay less than 1% interest. Every so often, an online account has a higher rate but it’s usually not anything to get overly excited about.
Banks lend money to people at rates that are higher than what they pay to their depositors. See, from the bank’s perspective, the 1% interest rate is a liability because the bank owes money to someone. Money that’s lent out to borrowers is an asset because it’s going to earn money for the bank.
If the bank owes Depositor 1% per year on a $10,000 bank account, then the bank has a $100 liability since it has to find a way to pay $100 to Depositor in a year’s time. How does the bank do that?
Easy. The bank takes the Depositor’s money – $10,000 – and loans it to Borrower at a rate of 5%. Borrower has promised to repay the bank $500 in a year’s time, because 5% of $10,000 is $500. The Borrower’s $500 debt is the bank’s asset.
The bank collects $500 from Borrower, and pays $100 to Depositor. The bank keeps the $400 spread for itself. Now, I’m sure there are expenses that go along with running a bank, procuring loans, administration of bank accounts, and staffing costs. Whatever is left after paying those expenses is the bank’s profit.
Banks are good at making profits.
Understanding the spread between what is owed to depositors and what is earned from borrowers is what keeps banks profitable.
So how do you turn this to your advantage?
It’s very simple, Gentle Reader. Banks are a tool for you as soon as you buy your first bank share.
Remember how I said that bank earnings are reported quarterly? One of the best features of banks is that they pay dividends to their shareholders. The more bank shares you own, the more dividends you’ll receive.
I used to get irate over bank fees. How dare the bank charge me for using my money? The little vein in my temple would visibly throb if ever I saw so much as a $1 taken from my account to cover an ATM withdrawal, or for anything else.
Eventually, this financial annoyance was removed from my life through 2 actions that I took. First, I opened bank accounts with institutions that did not charge bank fees for daily banking. I was no longer paying bank fees every month. Secondly, I started earning money from everyone else who chose to continue paying bank fees. I bought shares in banks and cashed the dividend cheques every quarter.
I can confidently say that the idea of bank fees no longer enrages me. Even if I do mess up and bounce a cheque, I might have to pay the $35 NSF fee. However, I know that I’ll be getting my money back in a few weeks’ time via my next dividend payment. That fee is a nuisance, but hardly a reason for me to get upset.
Banks are necessary.
I firmly believe that everyone needs atleast two bank accounts – a chequing account and a savings account. The chequing account is for your day to day money. It’s for receiving your paycheque, buying your groceries, paying utilities bills, and the expenses of day-to-day life. Your savings account is for your emergency fund. It’s meant to be a liquid pool of funds that can cover 6-12 months of your monthly expenses. Some people argue that an emergency fund can be 3 months of expenses. I’m a big believer in the idea that more money is better when an emergency strikes so it can’t hurt to have more than the minimum.
Banks are not evil, in and of themselves. Used properly, they facilitate the transfer of money into your investment account. You know that I’m a huge fan of automatic transfers. I’m a proponent of paying yourself first. A portion of every paycheque should be sent to your investment account, so that it can start working to ensure the Future You has a financially comfortable lifestyle.
For my part, I have several bank accounts. And all of them are designated for a specific purpose. Some accounts hold money for my annual travel. (Even during the pandemic, I’ve socked away a few coins for the eventual day when I feel comfortable enough sharing a plane with others.) Other accounts hold money for my annual insurance premiums and property taxes. I have an account for little luxuries like my theatre subscription to Broadway Across Canada. There’s also an account for maintenance and repairs to my home.
Again, banks are a tool – they’re not evil. Learn to use them properly and you’ll find that they offer many great methods for handling your money. Better yet, become a shareholder and receive a slice of their profits every three months. I’ve no doubt you’ll enjoy the feeling of the banks paying you instead of the other way around!