How Safe Are My Safe Retirement Investment?
Can I Still Lose Money In Safe Investment?
By Dana Anspach, About.com
All investments have risk, even “safe” ones. You are exposed to three types of risk with safe investment:
- The Potential to Lose Principal
- Loss of Purchasing Power Due to Inflation
- Illiquidity – Paying a Penalty to Get to Your Money
1. Potential to Lose Principal with a Safe Investment
What happens to my deposits if my bank goes under?
Your deposits in the bank are covered by
FDIC insurance. There is a limit to how much is covered. Typically the first $100,000 per account, per institution is insured.
As of October 2008, there is temporary increase in the
FDIC coverage limits to $250,000.
If you have funds in excess of the coverage limits, there are two ways to get additional coverage:
- Work with your banker to create multiple account titles, such as one account titled in the wife’s name, one in the husband’s name, one that is jointly titled, etc.
- Spread your funds across multiple institutions. Some banks will even do this for you by participating in a program that will allow them to place your money in certificates of deposit with other banks.
How safe is the money in my money market fund?
Money market funds own short term investments; some of these investments, called commercial paper, are very short term loans between companies. They are considered safe because the chance that a company will go out of business in the 30-120 days before the loan comes due is very small.
In September of 2008, the safety of these funds came into question, as the financial health of many companies came under scrutiny. To ease concerns, the treasury issued a
temporary guarantee to people who had deposits in money market funds as of
September 19, 2008. The institution which issues your money market funds has to pay to participate in this guarantee program.
Check with your institution to make sure they are participating. This guarantee does not cover new deposits made; only deposits that were in the money market fund as of
September 19, 2008.
What if the insurance company that issued my annuity policy goes under?
Insurance companies are required by law to keep substantial amounts of capital that remain available to pay claims. The higher the
rating of the insurance company, the safer their financial position, and thus the better their ability to pay claims.
If the company that issued a fixed annuity policy goes under, the National Organization of Life & Health Insurance Guaranty Associations (NOLHGA) ensures that insurance policies are transferred to a healthy insurer. While this process is occurring, your annuity could be frozen, and the income and principal may be unavailable to you until the transfer of assets to the new company is completed.
Assets in a variable annuity are considered assets of the policy holder, not assets of the insurance company, and thus assets in a variable annuity are not available to the insurance company’s creditors in the case of a bankruptcy.
2. Safe Investment Preserve Principal: But You Can Still Lose Purchasing Power Due to Inflation
When you choose to make a safe investment it means your main investment objective is preserving principal, even if that means the investments provide you with less income or growth. If there is little interest income, you can actually lose purchasing power over time.
For example, if your safe investment was earning 2% a year, and inflation was 4% a year, even though your princpal is safe, you are actually losing purchasing power.
3. Liquidity – Paying a Penalty to Get to Your Safe Money
Many safe investments contain surrender charges if you want to access your funds before the maturity date. In the case of certificates of deposit (CDs), the penalty may be small, such as a fee of 3 months worth of interest if you cash the CD in early.
In the case of fixed annuities, the penalty can be large, such as a surrender charge as high as 10% of your investment amount if you cash in the annuity too early.
With treasury bonds, if you hold them to maturity, you will get all of your principal back; but if you need to sell them prior to their maturity date, you may get more or less than what you paid for them, depending on the bond market at the time of sale.
One of the advantages to bank savings accounts and money market funds is that the money remains available to you at any time.
With safe investments, a good rule of thumb to follow is that the higher the interest rate, the less liquid the investment will be.
If you want to earn a higher rate of return than the savings account or money market fund offers, most institutions will require that you leave your funds invested for a minimum amount of time.
