Disintermediation refers to the flow of funds from a financial instrument to another, usually for the purpose of seeking higher returns and yields from the money.
With an eye on inflation which erodes the value of the money we have at hand, it’s no surprise these days to find new and veteran investors looking for places to park their excess funds so as to earn a higher interest.
It has become common knowledge for example, that savings accounts and fixed deposit accounts created by banks for consumers hardly generate enough interest earnings to keep up with inflation.
Thus, people who do not wish for their cash to slowly lose value constantly look for better financial instruments that allow their monies to grow.
In effect, they are directly investing their money themselves instead of leaving it to financial institutions and intermediaries.
Types of fund movements
When the products offered by banks are not attractive enough, there are various other places where the average consumer can transfer their funds to for better returns.
These include:
- Stocks
- REITs
- Index funds
- Bonds
- Insurance
- Brokerage accounts
- etc
When an economic down turn is projected for example, investors often transfer their funds into equities related to gold.
And when the cash value accumulated in life insurance policies are not performing well compared with the market, it’s not uncommon to find policy holders cashing out and moving their funds into other financial instruments such as treasury bonds.
In general when interest rate available to consumers rise, there is a tendency for disintermediation as savings move into better yielding investment-grade instruments.
Keeping their money with banks and insurance companies can be an opportunity cost. Even banks and insurers would probably be using the money of their customers to purchase better yielding financial instruments that are available to the general public.
It must be noted however, that disintermediation is a term that is usually only used to the transfer of funds from one generally stable and secure financial instrument to another.
Moving money into penny stock are typically not considered as disintermediation as it carries a lot of risks.
Home equity
Many homeowners consider their homes as the most secure investment they have made their in lives.
This is also why when their houses are not appreciating in value, they can sometimes choose to cash out the equity in the house so that home equity funds can moved to better investments that would be generating a better yield compared to zero appreciation.
This can make a lot of sense, especially when we consider that the mortgage loan balance continues to decrease and the home equity continues to increase even when there is no appreciation in value observed on the property.
While this can somewhat also be categorized as a form of disintermediation, one must take note that when attempting to do this, the interest rate on the home equity loan must be lower than the returns that alternative investments would generate.
Otherwise, it would make no financial sense and the home owner would be putting his or her house at risk at the same time.
