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Adapting the Concept of Sunscreen to Understand FDIC and SIPC Insurance

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Adapting the Concept of Sunscreen to Understand FDIC and SIPC Insurance

Summer solstice means that it’s time to re-stock the sunscreen.
 

There are a surprising number of factors to consider when choosing a blocker – smell, shimmer, thickness, packaging – but none are as important as Sun Protection Factor, or SPF. Despite popular belief, SPF count is not the number of hours or minutes you can be in the sun before you burn (there aren’t 30 hours of daylight, after all).

SPF works like this: if you tend to burn after 30 minutes in the sun, SPF 15 will protect your skin for 15 times longer, or seven and a half hours. Now that you know how skin protection works, we’d like to shed some sunlight on two other forms of protection for your cash and investments that are also often misunderstood: FDIC and SIPC insurance. 

FDIC Insurance protects clients of member banks from losses that result from a bank failure, afforded by the Federal Deposit Insurance Corporation, a US Federal Agency. FDIC coverage applies to cash-like instruments held by banks like checking and savings account cash, CD’s, and money market deposit accounts. It does not cover investments held at a bank, like stocks, bonds, or mutual funds. The limit of insurance afforded per bank is $250,000 per account registration.

For example, if you have an IRA account and an Individual account, each account has $250,000 of protection. The major function of this insurance is to offer peace of mind to depositors in order to avoid the It’s a Wonderful Life “run on the bank” scenario- attempting to grab as much money as possible before the bank is tapped dry. Know that banks don’t have 100% of deposits available for withdraw at a moment’s notice and, in fact, they are only required to maintain a small percentage of total deposits on reserve, freeing up funds for lending to homeowners, business owners and credit card users. Because of this, prior to the FDIC, mere rumors of bank trouble could have an unwarranted and devastating effect on banks.  

SIPC Insurance is to brokerage firms what FDIC is to banks.  The Securities Investor Protection Corporation (the SIPC) is a non-profit membership corporation created to provide a similar function as the FDIC but for securities (i.e., stocks, bonds, mutual funds, ETFs, etc.). It is important to understand that SIPC Insurance does not protect you from market movements or bad investments; it only protects you from losses incurred due to failure of the member brokerage firm.

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The current limit on SIPC coverage afforded per brokerage firm is $500,000 per account registration, of which only $250,000 can be for cash. This means that if you have $500,000 in your account, $300,000 of cash and $200,000 of stock, $50,000 of your cash is uninsured. There are two important caveats, however.

First, most firms are now associated with a FDIC member bank and sweep cash to the bank arm, giving it FDIC-level protection, instead of the lower SIPC limit on cash.

Second, most major brokerage firms purchase supplemental policies to provide more protection, some with limits that exceed $100 million per customer. SIPC coverage allows customers to feel comfortable keeping their investments in a brokerage account instead of holding physical certificates in a safe deposit box. It has increased the liquidity of the capital markets greatly, allowing investments to be bought and sold electronically without the need to move physical pieces of paper around.  

Unlike sunscreen, these coverages are not seasonal and should be understood year-round. Not sure if you’re covered? Confirm that your bank is a FDIC member and use this calculator to see if your coverage is adequate. Also, confirm that your brokerage firm is an SIPC member and go online to get details on their SIPC insurance supplement amount. 

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