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Thread: FDIC vs SIPC

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    Senior Member Gwennnnnn's Avatar
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    Default FDIC vs SIPC

    Okay, so I was all set to go open up an SEP IRA (besides being a dancer, I'm a freelance photographer/assistant) at Fidelity. Then I noticed that the IRA wouldn't be FDIC insured but SIPC insured. I HAVE done research and read through the SIPCs website, but I would like some further input/opinions (ahem, Melonie...) here on the differences between the FDIC and the SIPC.

    It says this on the SIPC website:
    "SIPC is not the FDIC. The Securities Investor Protection Corporation does not offer to investors the same blanket protection that the Federal Deposit Insurance Corporation provides to bank depositors.

    How are SIPC and the FDIC different? When a member bank fails, the FDIC insures all depositors at that institution against loss up to a certain dollar limit. The FDIC’s no-questions-asked approach makes sense because the banking world is “risk averse.” Most savers put their money in FDIC-insured bank accounts because they can’t afford to lose their money.

    That is precisely the opposite of how investors behave in the stock market, in which rewards are only possible with risk. Most market losses are a normal part of the ups and downs of the risk-oriented world of investing. That is why SIPC does not bail out investors when the value of their stocks, bonds and other investments falls for any reason. Instead, SIPC replaces missing stocks and other securities where it is possible to do so ... even when the investments have increased in value.

    SIPC does not cover individuals who are sold worthless stocks and other securities. SIPC helps individuals whose money, stocks and other securities are stolen by a broker or put at risk when a brokerage fails for other reasons."

    ...but I'm still confused... I'm VERY new to investing.. so forgive me...
    But is it better to open an IRA that's FDIC insured rather than SIPC insured??

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    Banned Melonie's Avatar
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    Default Re: FDIC vs SIPC

    the essential difference actually pertains to a so-called 'bank' CD being a deposit, whereas a so-called 'investment' CD is a security. The 'bank' CD has a fixed dollar amount of principal which the FDIC will 100% insure (as long as your total deposits don't exceed their $100k limit). On the other hand an 'investment' CD has a certain dollar price when purchased, but no ironclad guarantee that the dollar price will be the same when sold (just like shares of stocks and just like bonds). Thus while the SIPC guarantees that the 10,000 'shares' of an investment CD fund or money market fund or common stock will be replaced if the investment bank / brokerage goes belly-up, the SIPC does NOT guarantee that those 10,000 shares will be worth the same price you initially paid for them.

    In general, investment houses go to great lengths to make sure that their investment CD funds and money market funds never 'break the buck'. If the underlying investments in such CD funds or money market funds lose money, rather than allowing the price of those funds to drop from the original $1.00 a share to 95 cents (for example), the investment house will typically waive management fees or even transfer money from other sources to maintain the original $1.00 per share price. However, if and when the investment house were to go belly-up, the share price at SIPC liquidation could indeed fall to 95 cents or 90 cents or 80 cents or theoretically 50 cents per share. As a result, if you had invested $10,000 in such an investment fund at $1.00 per share, the SIPC could pay your back $9,500 or $9,000 or $8,000 or theoretically $5,000 in exchange for those 10,000 SIPC insured shares when market conditions are unfavorable. This is quite different from a $10,000 'bank' CD or money market account where the FDIC guarantees to pay you back the full $10,000 !

    On the flip side, when all goes well the 'investment' CD funds and money market funds typically pay higher interest rates than the 'bank' equivalent CD's and money market accounts. And depending on the nature of the underlying investments behind an investment CD fund or money market fund, it's also possible that the SIPC could pay you back $10,500 or $11,000 in exchange for your $10,000 shares in the event of an investment house going belly-up while market conditions are favorable. This comes back to the 'risk versus reward' equation the SIPC blurb was talking about.

    As to which is 'better', this is a very individual decision ... which will be based on risk tolerance, years remaining until official retirement age is reached, current economic conditions etc. In my own personal case I prefer to park my 'cash' in bank CD's (and not under the umbrella of a tax deferred IRA). But I usually have far more money invested in stocks, bonds, and occasionally funds (also not under the umbrella of a tax deferred IRA). At the moment my only 'qualified' retirement investment is a 401k left over from my days working a 'straight job' as a respiratory therapist. Putting money in any form into a tax deferred IRA actually involves a whole 'nuther set of risks ... but that discussion is beyond the scope of this thread.

    ~
    Last edited by Melonie; 08-05-2008 at 03:32 PM.

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    Senior Member Gwennnnnn's Avatar
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    Default Re: FDIC vs SIPC

    Thank you Melonie. I appreciate your input.

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