Online banks vs. brick-and-mortar

I am (barely) old enough to remember when the general public was skeptical of banking online and preferred face-to-face banking rather than using a website or app. Now, only 29% of Americans prefer banking in-person. Almost all brick-and-mortar banks offer online services to their customers, but they still lag behind in many key areas. Online-only banks offer APYs 10x higher than traditional banks. It’s not all the fault of the brick-and-mortar bank; the cost to maintain physical locations certainly means they can’t compete as well on savings account interest rates.

We don’t necessarily advocate for dumping your brick-and-mortar bank, but we do think everyone should at least investigate whether or not an online bank might be a better solution for your savings account due to the difference in interest rates. If you don’t mind having more than one bank in your life, you could keep some money at your local bank and the rest in an online, high-yield savings account. There are valid reasons to utilize the services of a brick-and-mortar bank. If you are a server or in another industry where you handle a lot of cash, it is much easier to deposit that cash if you have a physical bank to go to. Sometimes it’s just easier to go down to your local bank and talk to someone rather than dealing with online customer support. An online bank may be able to meet all of your banking needs, but some still need, or want, the services offered by a brick-and-mortar bank.

How to choose the right online bank

Online banks attract consumers because of their convenience and higher interest rates than brick-and-mortar competitors. For those worried about safety, online banks typically have the same FDIC coverage as traditional banks. For most consumers, your money is just as safe at an online bank and you get the convenience of banking online and are typically rewarded with higher interest rates.

There are more online banks now than there were in the past, but a large number of them aren’t actually banks. Many of the most popular and fastest-growing banks aren’t actually banks at all, but financial technology companies backed by real banks, or neobanks. This isn’t necessarily a problem, as your money is still technically held at a real bank that is almost always FDIC-insured, but it can cause some issues you wouldn’t experience if you were using a real online bank.

Yotta is a popular financial technology company, or neobank, that has gamified saving money on their platform. They may have taken it a little too far, leaning too heavily into the gamifying aspect of their services, and ultimately, turning into a form of gambling. Now customers are unable to get their money out of the financial technology company. Perhaps the largest bank-that-isn’t-actually-a-bank, Chime, has its own share of unique issues. I am a former customer of Chime and was a little unsettled reading horror story after horror story of other customers having their account closed for no reason and often unable to get their money back. ProPublica covered the issue in-depth and made sure to emphasize that Chime was not, in fact, a bank.

The worst-case scenario of your account being closed or being unable to access your money might not happen to you, but I have found financial technology companies that offer banking services prioritize the technology over the banking services. With my former neobank, the website was seriously barebones, and you could only do most things from the app. This isn’t always a problem, but sometimes I only had access to my computer. The final straw was being unable to order checks. Yes, I know hardly anyone uses checks anymore, and I use them so infrequently that it hadn’t been an issue, but my neobank was unable to provide me with checks even though I was willing to pay for them.

Online banks are great, but it may be worth sticking with an actual online bank instead of a financial technology company that isn’t a true bank. Myself and some others at The Money Guy Show use Ally Bank. They offer competitive savings account rates and they have been in business for over 100 years now. No matter what bank you end up choosing, look for a bank that is actually a bank, is FDIC insured, offers competitive rates, and didn’t just pop up overnight.

A checking account at a bank isn’t as sexy as a Roth IRA or 401(k), but having a great bank is foundational to your financial life. It can mean the difference between your money being there when you need it or your money not being there. A higher yield on your savings account might mean achieving financial goals, like saving for your first home, just a little bit sooner. Don’t overlook your decision of who to bank with, and while switching banks is never easy, it could put extra money in your pocket or even save you from a nightmare scenario of losing access to your money.

What happened at Silicon Valley Bank?

Banks are for-profit institutions. While many customers don’t pay for banking services directly, banks still make money by using customer deposits to loan out or invest in generally low-risk investments. Banks are required to keep only a fraction of deposits on-hand for withdrawal at any given time. This means that if everyone shows up and demands their money back from the bank at the same time, not everyone will be made whole (by the bank; the FDIC covers deposits, up to certain limits, in such situations).

Normally, this isn’t a problem because people trust that banks are going to have their money when they need it, so they don’t all show up at the bank at the same time demanding their money. As long as everyone trusts the bank, everything usually works out fine. Problems occur when trust in the bank is shaken – and that is what happened with Silicon Valley Bank.

A significant portion of customer deposits at SVB were invested in U.S. government bonds. Government bonds are considered a safer investment, but they can go down in value. If you bought a $100 bond from the government last year paying 1%, it will be worth less if someone can now buy a $100 bond paying 4%. This isn’t a problem if you can hold your bond to maturity: you’ll get your $100 back from the government, plus the 1% per year. It’s a problem when you are forced to sell your bonds on the open market because customers want their money back.

The situation at SVB is a bit more complicated, but you get the picture. Deposits were tied up in bonds that had gone down in value, customers became nervous and started a run on the bank, then the government stepped in. The situation at SVB was unique because the vast majority of customer deposits were uninsured – more so than any other large bank in the U.S.

The amount of deposits not covered by the FDIC could have made customers a little more nervous they wouldn’t get their money back, and added a little extra fuel to the fire. Ultimately, the Treasury, Federal Reserve, and FDIC announced that all customer deposits, even amounts over $250k, would be backstopped by the federal government.

What if my bank collapses?

Bank failure is not a common occurrence, but it isn’t rare, either. Two large banks recently collapsing (and some others having financial troubles) does make customers more on edge about their own bank, and even if a bank is not in any bad financial trouble, bank runs could still cause a bank to collapse.

Most Americans have less than $250,000 in cash (in fact, most have less than $1,000 in cash) and are fully covered under the FDIC. If you have more than $250,000 in cash, there are ways you can increase your FDIC coverage. One is adding a joint owner to your account, which increases your coverage to $500,000. Different institutions have separate coverage limits, so opening an account at another bank can increase your coverage (credit unions also have separate coverage under the NCUIF). You could also open an account with a different registration type at the same bank, like a trust, that qualifies for separate coverage.

What about my investment accounts?

Most don’t have to worry about exceeding the FDIC coverage limits, but many more Americans have a significant amount of investments. How is that covered, or is it covered at all?

SEC rules prevent brokerage firms from using your assets for their own business. Custodians keep assets segregated, which means even if your brokerage went bankrupt, your investments should be returned to you or transferred to another provider. Consider investing with a brokerage that has been around a long time and is transparent about how they handle customer assets. Fidelity, Vanguard, and Charles Schwab all fit the bill.

It is possible that not all brokerage firms operate within the bounds of the law, and customer assets could be missing if a brokerage firm went bankrupt. If this were to happen, assets would be covered under the Securities Investor Protection Corporation, or SIPC. It covers up to $500,000 in securities, including money market funds, and up to $250,000 of cash held in a brokerage account. Many brokerages carry coverage in excess of SIPC coverage, which kicks in if SIPC coverage were ever exhausted. If you are concerned, check with your broker to see exactly what coverage your accounts are eligible for.

It’s important to remember that while security holdings are protected under the SIPC, the value of those securities is not. It is always possible for investments to go down in value and lose money. If you have other concerns or questions about the recent collapse of SVB, make sure you check out our recent Q&A or watch it on YouTube below.

We put a lot of trust and faith in banks and investment firms to be good stewards of our hard-earned resources. It is frightening whenever something happens that causes us to question that trust and faith. We have experienced large banking collapses before, and are grateful for the safety nets put in place to ensure your assets are protected. The events surrounding SVB should serve as a spot check for your financial well-being. If you had a good plan before SVB collapsed and were banking at reputable institutions, that plan should continue to serve you well. Don’t get caught up in a cycle of irrational fear and make a poor decision that could negatively impact your financial future.