By Dr. Jim Dahle, WCI Founder

Given prominent bank failures in 2023, many investors have been wondering about the safety of their “safe investments,” particularly their cash. While some investments are protected or insured, investing is mostly about risk control. It is important to understand the risks you are taking.

 

What Are Safe Investments?

My definition of a safe investment is an investment in which you are unlikely to lose a lot of money, at least on a nominal basis. It may be easiest to define a safe investment by what it is not. It is not a speculative investment—such as empty land, currencies, derivatives, cryptoassets, or precious metals—where you are reliant on someone else paying you more for your asset in the future than you paid for it. It is not an equity investment in stocks or real estate or a small business where you often experience high volatility of value and income and even permanent loss of capital. It is not junk bonds, peer-to-peer loans, or even real estate debt funds where default is common. It is not long-term bonds where changing interest rates can decimate the principal value should you need to liquidate the investment early.

The main risk with safe investments is simply that your money will not grow fast enough to keep up with inflation and/or reach your financial goals. The risk of loss on a nominal basis should be minimal. Thus, safe investments include things such as:

  • Checking accounts
  • Savings accounts
  • Money market funds
  • Certificates of Deposit (CDs)
  • Savings bonds (EE and I)
  • Treasury bills
  • Short-term, investment-grade Treasury, corporate, and municipal bonds
  • Short-term TIPS
  • TSP G Fund
  • Whole life insurance

While it is possible to lose principal with each of these investments, you should not lose a lot of principal with any of them. Each of these investments comes with guarantees and possibly even insurance.

 

Who Provides the Guarantee?

The most important thing to understand about a guarantee is who provides it.

 

 

It feels good to have a guarantee, but if the entity providing it fails, then the guarantee is worthless. Consider the entity guaranteeing each of those safe investments:

  • Checking accounts, Savings accounts, CDs: The individual bank
  • Money market funds: The entity borrowing the money (corporations, governments)
  • Savings bonds (EE and I), Treasury bills, short-term Treasury bonds and TIPS, TSP G Fund: The US government
  • Short-term corporate bonds: Individual corporations
  • Short-term muni bonds: State and local governments
  • Whole life insurance: The insurance company

Each of those types of entities has let down its lenders in some way at some point in the past, including the US government. While that risk is low, it's not zero. For theoretical purposes, Treasury bills are considered a “risk-less” asset. But there really is no such thing.

More information here:

Where to Store Your Money

 

Insurance on Safe Investments 

In addition to the guarantee, some safe investments are also backed by another entity that is insuring your assets. Let's talk about each of these types of insurance and their limitations.

 

Federal Deposit Insurance Corporation

The Federal Deposit Insurance Corporation (FDIC) was started during the Great Depression to prevent runs on banks and to provide for an orderly transition when banks fail.  Before then, you had better pick your banks carefully, because if they went bust, you were hosed. Currently, the FDIC insures bank deposits up to $250,000 per depositor, per bank, and per ownership category.

 

What Does the Federal Deposit Insurance Corporation Do?

If a bank fails or is about to fail, the FDIC will step in and take over. It usually happens very quickly, and within a day or two, you will have access to your money—as long as you had less than $250,000 in that bank.

There is no reason I can think of to use a bank that is not FDIC-insured. Although rare, they do exist, and they are often backed by something else. The Bank of North Dakota, for instance, is backed by the state of North Dakota. Foreign banks are not backed by the FDIC, but their country may have a similar institution.

FDIC limits are $250,000 per depositor, per bank, and per ownership category. If you are married and have a joint checking account at a bank, up to $500,000 in that account will be insured. If you have more money than that, you can simply go to another FDIC-insured bank, open up another joint checking account, and get another $500,000 in FDIC coverage.

The depositor and bank limits are pretty straightforward, but what does the “per ownership category” mean? It does NOT mean the type of deposit product. You don't get $250,000 in your checking account plus another $250,000 in your savings account plus another $250,000 in your money market account plus another $250,000 in CDs. Those are deposit products. Ownership categories include:

  • Single accounts
  • Joint accounts
  • Trust accounts (including informal revocable trust accounts such as “pay on death” accounts)
  • Business accounts
  • Certain retirement accounts
  • Employee benefit accounts

I bet you now have the wheels turning in your head, right? I hope so. How much could you have in a single bank and have it all be insured by the FDIC? Let's add it up.

  • Your single account: $250,000
  • Your spouse's single account: $250,000
  • Your joint account with your spouse: $500,000
  • Your daughter's single account: $250,000
  • Your son's single account: $250,000
  • Your joint account with your daughter: $250,000
  • Your joint account with your son: $250,000
  • Your business account: $250,000
  • Your spouse's business account: $250,000
  • Your IRA (you liked the bank's CDs): $250,000
  • Your spouse's IRA: $250,000
  • Your revocable trust naming your two kids: $500,000
  • An irrevocable trust naming your spouse as the primary beneficiary and the two kids as contingent beneficiaries: $250,000

Total: $3.75 million

Plus, you could go down the street and open up each of these accounts again at a different bank for another $3.75 million in coverage.

Note that the trust rules are fairly intricate. As a general rule, you get $250,000 for each non-contingent beneficiary of the trust that is a living individual or a nonprofit. Also note that some items are not covered by the FDIC, even if they are purchased from an FDIC-insured bank and even if held inside an insured account such as an IRA at the bank:

    • Stocks
    • Bonds
    • Mutual funds
    • Treasury bills
    • Annuities
    • Life insurance policies
    • Municipal securities
    • Safe deposit boxes or their contents

 

National Credit Union Administration

bank run

The National Credit Union Administration (NCUA), founded in 1970, is basically the same thing as the FDIC but for credit unions instead of banks. The amounts of coverage and limitations work the same way. Both the FDIC and NCUA are agencies of the federal government.

 

Securities Investor Protection Corporation

The Securities Investor Protection Corporation (SIPC) was formed via the Securities Investor Protection Act of 1970 in response to a bunch of broker-dealers merging, being acquired, or going out of business during turbulent markets in 1968-1970. When that occurred, many of these brokerages could not meet their obligations to customers when they were going bankrupt. Public confidence in the securities markets was tanking so Congress stepped in to protect customers against CERTAIN KINDS of losses. Since 1970, the SIPC has advanced $3.1 billion to help 773,000 investors recover a total of $141.8 billion.

Initially, the SIPC provided up to $50,000 in coverage, including $20,000 in cash. However, those amounts increased in 1978, 1980, and 2010. The current protected amount is $500,000, including up to $250,000 in cash. Notable successes of SIPC include the eventual recovery of 100% of customer money in the Lehman Brothers meltdown, 100% of customer money in the MF Global Inc. liquidation,  and 100% of customer money in the Bernie Madoff scandal (for those who had less than $1.7 million invested; those with more have only received 70% of their money back.)

The SIPC is NOT a government agency, even though it was created by federal law. It is a nonprofit membership corporation with a $2.5 billion line of credit from the US Treasury. It is NOT the FDIC of investments. Its mission is this:

“SIPC oversees the liquidation of member firms that close when the firm is bankrupt or in financial trouble and customer assets are missing. In a liquidation under the Securities Investor Protection Act, SIPC and the court-appointed Trustee work to return customers’ securities and cash as quickly as possible. Within limits, SIPC expedites the return of missing customer property by protecting each customer up to $500,000 for securities and cash (including a $250,000 limit for cash only).

SIPC is an important part of the overall system of investor protection in the United States. While a number of federal and state securities agencies and self-regulatory organizations deal with cases of investment fraud, SIPC's focus is both different and narrow: restoring customer cash and securities left in the hands of bankrupt or otherwise financially troubled brokerage firms.”

The job of the SIPC is to get you your money. Unlike a bank, a broker-dealer is not engaging in fractional banking. Your money is there, invested in securities that have real value even if the brokerage fails. You can get the money out; it just takes some time and effort. In the meantime, the SIPC gets you some of your money right away using that line of credit from the Treasury and facilitates the liquidation of the brokerage to get you the rest of your money. It protects you from fraud and bankruptcy of the broker. What it does NOT protect you from, however, is investment losses. It'll get the money you invested in that mutual fund. But it won't get you money that the mutual fund lost. The SIPC does NOT protect you against market losses in the value of your shares. I repeat:

The SIPC does not protect you against market losses in the value of your investment!

There are some other things the SIPC doesn't cover. While it does cover losses from unauthorized trading or theft from an account, it does not cover a hacked account unless that hack forced the firm into liquidation. It also does not cover losses due to bad, inadequate, or inappropriate advice from the broker-dealer. It also doesn't cover investments that aren't registered with the SEC, including commodity futures, fixed annuities, currency, hedge funds, syndications, limited partnerships, or private funds. Accounts of partners, owners, and officers in the failed firm are also not covered.

 

State Insurance Guaranty Associations

Similar organizations exist in the insurance world. These are organized by state and known as state insurance guaranty associations. These are simply composed of the insurance companies operating in that state. So, your insurance company is, to a certain extent, backed up by other insurance companies. This matters if you are investing in annuities and cash value life insurance and even if you just have a regular insurance policy that you need benefits from at the time the company fails. If your insurance company fails, that state insurance guaranty association may cover some of your loss. The idea is to protect the policyholders from an insurance company going bankrupt. This does happen, although, in recent years, fewer than 10 insurance companies per year go bankrupt. 1992 was a particularly bad year with 50 bankruptcies.

When a state insurance commissioner determines a company cannot be rehabilitated, the company is declared insolvent, and the state court is asked to order a liquidation. Company assets are seized, and the commissioner runs the liquidation with or without the assistance of a “receiver.” Think of a receiver as the executor of the insurance company's will. This person adds up all the assets and liabilities, tries to maximize the assets, liquidates them, and then distributes the cash to the creditors of the company in accordance with state law. As a general rule, policyholders are priority claimants who are more likely to get their money than the general creditors of the company.

The State Insurance Guaranty Association ensures that each policyholder gets at least a certain amount from each type of policy. These limits vary by state but there is pretty good uniformity between states. Any amount above and beyond these limits becomes a claim against the general assets of the failed insurance company. The general limits are as follows:

  • $300,000 in life insurance death benefits
  • $100,000 in cash surrender or withdrawal values for life insurance
  • $250,000 in present value of annuity benefits, including net cash surrender/withdrawal values
  • $500,000 in major medical or basic hospital, medical, and surgical insurance policy benefits
  • $300,000 in long-term care insurance policy benefits
  • $300,000 in disability insurance policy benefits
  • $100,000 in other health insurance benefits

Note that most of the protection here is for BENEFITS, not cash value. There is also generally an aggregate limit of $300,000 per company (a little higher if including health benefits), no matter how many types of policies you have. If you have three separate whole life policies with the same failed company, you could have as much as $300,000 in protected cash value, but if you had three separate annuities, you would still only have $300,000 protected.

It's important to understand what is really going on here, though. The FIRST thing paid from company assets are these guaranteed amounts. The other insurance companies in the state really aren't on the hook for much here. They don't provide these amounts from their own assets unless the assets of the failed company are not sufficient. That makes it much harder for a large policyholder to recover amounts above and beyond these guaranteed limits. In most states, the insurance companies are not even assessed a premium until there is an insolvency, and those premiums are capped at 2% of total insurance premiums for that company in that state.

More information here:

Does Your Savings Account Yield Round to Zero?

 

What Is a Bank Run?

The FDIC was mostly put in place to stop bank runs. Banks do “fractional banking”—that is they lend out money that they do not have on deposit. Thus, if every depositor demanded all of their money at once (a bank run), the bank could not pay everyone and would fail. Fractional reserve banking allows banks to legally lend out some of the money they have on deposit. Regulators used to require them to keep a minimum in the bank. This is known as a “reserve requirement.” Historically, this has been 10%, so if a bank took in a $100,000 deposit, it could then lend out $90,000. Of course, that borrower could then deposit that $90,000, and $81,000 of that could be lent out and so on and so forth until that $100,000 theoretically becomes $1 million in our system. That reserve requirement was actually changed from 10% to 0% in March 2020, and it's remained there since.

In practice, few banks get anywhere near that 10% level. You can look up the totals for US banks on the Federal Reserve website. For example, there were $16 trillion in deposits at “domestically chartered commercial banks” recently but only $2 billion in cash and only $5 billion in securities. If we all wanted our money back today, we couldn't get it. That's because the banks have loaned it all out to us. The bank can't give you your money because it gave that money to Sally down the street (in the form of a mortgage) to buy her house.

If you had more than the FDIC limits deposited in a bank and there was a bank run that caused the bank to fail, you could lose the amount above and beyond the deposit limits. The FDIC would provide you the FDIC limits immediately and do the best it could to use the other assets of the bank (including all those loans to the Sallys of the world) to get you as much of it as possible in the end.

When Silicon Valley Bank failed earlier in 2023, the Fed and FDIC did something unusual. They announced they would back ALL of the deposits, not just the amounts covered by the FDIC limits. They weren't going to bail out the bank's shareholders, but they also weren't going to make the bank customers pay for the mistakes of the bank. Whether that will happen again in the future is unknown, but there is certainly talk in Washington about raising the FDIC limits, including making them infinite.

More information here:

Will I Be Protected If My Investment Broker Goes Bankrupt?

 

Can a Money Market Fund Have a Run?

My favorite alternatives for cash are high-yield savings accounts at an FDIC-insured institution and money market funds from blue-blood institutions such as Vanguard. Some people worry about whether their money market fund could have a bank run. However, since money market funds do not do fractional banking, they really couldn't have one.

But keep in mind what a money market fund is. A money market fund is a mutual fund where the manager lends out the money by purchasing very short-term securities. Depending on the type of money market fund, this money may be lent out to corporations (Prime), the US Treasury (Treasury), US agencies (Federal), or state and local governments (Municipal). These loans have terms ranging from days to months. The primary goal of a money market fund manager is to ensure the return of your principal, not necessarily to earn a high return on your principal. They want you to get your money when you need it and maintain a stable share value of $1. However, if everyone wanted their money back at once, a manager MIGHT have to limit withdrawals (redemption gates) for a few days or even months until that money comes back into the fund (once these short-term loans are paid off). A money market fund might also have to “break the buck” if the value of those loans drops significantly. Retail money market funds have never done this, but institutional ones have. This was a big concern in the Global Financial Crisis of 2008.

However, like any mutual fund, there are underlying investments in a money market fund that have some value. There is no fractional banking going on here. If the money market fund has $10 billion in it, there really is $10 billion in securities in that fund—not just $3 billion like a bank. While there is some risk you could lose access to your money for a few weeks or even lose 2% of it if the fund breaks the buck, the risk of massive loss like you have for large deposits at a bank really doesn't exist.

 

The Role of the US Government

In reality, most of the guarantees and insurance for your safe investments are coming from the US government. This includes FDIC- and NCUA-insured bank deposits and CDs. This includes Treasury bills and bonds and savings bonds. This includes the line of credit for the SIPC. The US government has a strong military, powerful institutions, the ability to tax the world's largest economy, and the ability to print money (which so far is still the world's reserve currency.) It's not a bad institution in which to place your faith. But it also is not impossible for it to fail.

The history of the world is a long list of failed empires. Of course, if the US fails in all of its guarantees, the best investment is probably ammunition and canned food rather than some other investment. Nevertheless, some people view a small allocation to a speculative instrument such as precious metals or a cryptocurrency as a bit of insurance against this possibility.

 

Investing is more about risk control than seeking returns. While cash and your other safe investments are low risk, they are not zero risk and it is important to understand the risks you are taking.

What do you think? What have you done to maximize FDIC insurance? What safe investments do you worry about most? Comment below!