Is Your Money Safe?

When you think about all the financial questions you could ask, this is probably the most important. Am I right? It’s the fundamental question and one that you’d expect a simple straight-forward answer to. The good news is that there are straight forward answers to this question. The bad news is there is more than one answer and you may not want to hear them all. None-the-less, it’s to your credit that you ask and it’s to your benefit to understand. Let get to it.

What is Safe?

In order to know if your money is safe or not we have to first define our terms. There are a number of ways to define safety. First is the issue of capital; is my capital guaranteed and insured? If so, by whom and are they credible?

And the second level of safety concerns the returns and/or income; how much will I receive, who guarantees or insures that return and for how long?

Insurance On Your Capital

There are a few investments that are insured but not many. First are bank CDs which are insured by the FDIC. This is a government agency. They insure CDs up to $250,000 per depositor depending on the kind of account you open.

Next are bonds. Most bonds are not insured but simply backed by the issuer. Still, there are some that do carry coverage. Just keep in mind that this is private insurance and not backed by the U.S. Government. So long as the insuring entity is solid, you are fine. If not, the insurance isn’t worth the paper it’s printed on.

Last, if you have investments at a brokerage firm and they are a member of SIPC, your account is protected against the loss of cash and securities up to $500,000 in case the brokerage firm goes belly up. The $500k is the aggregate coverage of which $250,000 covers the cash in your account.

It’s important to understand that this doesn’t protect you if the securities held in your account lose value. So if you buy worthless stocks or get bad investment advice SIPC won’t give you a nickel.

Guarantees On Your Capital

While insurance is usually the best way to safeguard your money, guarantees can be helpful too. The U.S. government doesn’t insure its securities but it stands behind the Treasury Bills, T Notes and T Bonds they sell. That’s about as solid as you can get.

Also, insurance companies usually guarantee the fixed annuities they sell. Again, that’s fine as long as the company stays in business.

How Safe Is Your Income?

If you investment is insured so is the return in most cases. The same thing holds true for guaranteed investments. When an institution guarantees your investment they usually guarantee the income. Keep in mind that what you earn (the returns) can be very different from the income you draw from your investment. You might earn 4% from your investment but withdraw only 2% for example or vice versa. The point is your earnings might be insured or guaranteed but if you withdraw more than your guaranteed earnings, those excess withdrawals are not covered.

What About Inflation?

There are very few investments that insure or guarantee to bump up your income to protect you from inflation. With fixed income investments like bonds and annuities the rates are almost always going to stay the same. That is precisely why I don’t like these investments for most long-term investors.

Over the last 10 years inflation has averaged roughly 2.29% and over the long-term you’re looking at 3.22%. Even at that “low” rate, your cost of living will double every 23 years. In only 13 years the cost of living will be 50% higher. To me, buying an investment that will provide a fixed return that in 23 years is almost guaranteed to be worth half what it is now sounds extremely risky.

This is why I love to use growth and balanced mutual funds to create income. The values aren’t insured or guaranteed. That means your withdrawals aren’t guaranteed either. But given the alternatives, using equity growth to battle inflation is a strong alternative for long-term investors– even though there are no guarantees for the principal or the earnings.

The Bottom Line On Investment Safety

When you think about safety, think about the safety and risks of your invested capital, the earnings and how those earnings will keep up with inflation. Then think about your time-frame and (most important) prioritize what’s most important to you.

If your greatest concern is safety of principal and you are OK with the reality that your income may not keep up with inflation, you should probably stick with very conservative investments. If on the other hand you perceive inflation as the greatest risk to you over the long-term and you are willing to sacrifice stability of principal, lean towards growth alternatives.

What is the investment risk you are most concerned about? Why? What are you doing about it?