Should you invest in bank shares or bank deposits?

On 11th February 2008 I wrote a blog pointing out that rather than placing funds on deposit with a major bank, investors might like to consider buying shares in the bank instead. I pointed out that over the past 10 years this would have resulted in vastly superior returns.

I did not recommend that people switch to shares because I believe that investing in shares should be a long term proposition and funds on deposit are often required it the short-term. Obviously you should be very cautious about investing funds in shares that you are likely to need on a specific future date because if that date falls in a period of depressed share prices, you are likely to crystallise a loss. And individual investor circumstances need to be taken into account as well.

Having said that, I thought it might be interesting to compare the performance of bank shares with interest rates now that we have had had such a dramatic collapse in share prices. Does my suggestion that you would get better returns on bank shares rather than bank deposits still hold water?

Set out below is a Sharesight screenshot of a portfolio of shares in the four major banks. Initially $1,000 was invested in each bank on 28 July 1999. You will see that the compound return across the four major banks over the last 10 years has been 10.31%. This sure beats deposit rates.

What may surprise a little, is that over the last 5 years combined bank returns have been 9.61%. Maybe even more surprising, is that over the last year they have been 11.26% -- see the second screen shot.

So are bank shares always going to give superior returns to bank deposits? History says usually but not always. No comparison is complete without noting the following:

1. You will see from the second screen shot that individual bank returns over the last year have been volatile.

2. Shareholders are last cab off the rank in the extremely unlikely even that disaster strikes and a bank falls over. So in theory they carry greater risk.

3. And finally, if you look at bank returns over the past 2 years - see the screen shot below -- you will see that deposits win out handsomely. The banks’ overall return was -8.01% with ANZ and NAB taking a beating.

Disclosure: I have no shares or investment deposits in any bank.

This information is not a recommendation nor a statement of opinion. You should consult an independent financial adviser before making any decisions with respect to your shares in relation to the information that is presented in this article.