Do Safe Investments Carry Risks?
How conservative investment options can have their risks
By: Dana Anspach
Dana Anspach is a certified financial planner and expert in investment and retirement planning. She is the founder and CEO of Sensible Money, a fee-only financial planning and investment firm.
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Updated on December 27, 2021
Reviewed by: Michael J. Boyle
Michael Boyle is a seasoned financial professional with over 10 years of experience in financial planning, derivatives, stocks, fixed income, project management, and analysis.
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All investments carry risks, even safe investments
You are exposed to the following risks with safe investments: the possibility of capital loss, loss of purchasing power due to inflation, and illiquidity – paying a penalty to access your money. Let’s take a look at how these risks may affect how you use safe investments in your plan. Although unlikely, sometimes people lose money in safe investments. Here are some possibilities.
If Your Bank Fails
Your deposits in the bank are protected by the government through the Federal Deposit Insurance Corporation (FDIC). There is a limit on the amount covered. Typically, the first $250,000 per account, per institution is insured. Before 2008, this limit was $100,000, but during the 2008 crisis, the limit was raised and made permanent in 2010. If you have money exceeding the coverage limits, there are some ways to obtain additional coverage: work with your bank to create multiple account titles, such as one in the name of the first spouse, one in the name of the second spouse, one joint, and so on. Spread your money across multiple institutions. Some banks may even do this on your behalf by participating in a program that allows them to place your funds in certificates of deposit with other banks. Use a brokerage account and buy certificates of deposit from different banks within it. You have $250,000 coverage at each institution, so if you have four certificates of deposit from four banks, each for $250,000, you will have a million dollars covered.
If the Value of Your Money Market Fund Drops
Money market funds invest in short-term securities; some of these investments, such as commercial paper, are short-term loans between companies. They are considered safe because the chance that the company will go bankrupt before the loan matures in 397 days (or less) is low. In September 2008, the safety of these funds came into question as the financial health of many companies was scrutinized. To alleviate concerns, the Treasury Department issued a temporary guarantee for those who held deposits in money market funds. The institution that issued your money market fund had to pay to participate in this guarantee program. This program is no longer in place. Money market funds aim to maintain a stable price of $1.00 per share. Additionally, they earn interest; however, many funds are currently paying very little interest in the low-interest-rate environment.
If Your Insurance Company Goes Bankrupt
Insurance companies are legally required to hold significant capital amounts readily available to pay claims. The higher the rating of the insurance company, the stronger its financial position, and therefore its ability to pay claims.
If the company that issued your fixed retirement policy goes bankrupt, the National Organization of Life and Health Insurance Guaranty Associations (NOLHGA) guarantees the transfer of insurance policies to a health insurance company. During this process, your retirement funds may be frozen, and income and capital may not be available to you until the asset transfer to the new company is completed.
Considered
The assets in variable insurance are assets of the policyholder and not assets of the insurance company, and therefore the assets in variable insurance are not available to the creditors of the insurance company in the event of the company’s bankruptcy.
Loss of Purchasing Power Due to Inflation
When you choose to make a safe investment, that means your primary goal in investing is to preserve capital, even if that means the investment provides you with less income or growth. If there are low interest revenues, you can actually lose purchasing power over time.
For example, if your safe investment earns 2% annually and inflation is 4% annually, even though your capital is safe, when you go to spend that money, it won’t buy the same amount of goods and services as it did before. This means you are effectively losing purchasing power.
Most people consider the risk of capital loss to be the greatest danger. However, if you have a long time horizon, the loss of purchasing power due to inflation can act like erosion and cause significant damage overall. If you have a long time horizon, to avoid losing purchasing power, consider moving some long-term investments into growth or income options.
Illiquidity: Paying a Penalty for Accessing Your Safe Money
Many safe investments carry surrender fees, which means you’ll pay a fee if you want to access your money before the maturity date. The further away you get from the maturity date, the less liquid the investment becomes.
In the case of certificates of deposit (CDs), the early withdrawal penalties might be small, like a penalty equal to three months of interest. In the case of fixed insurance, the early withdrawal penalties can be significant, such as surrender fees up to 10 or 15% of your investment amount.
One advantage of bank savings accounts and money market funds is that the funds remain liquid, meaning they are available to you at any time without penalties. If you are willing to tie up your money for long periods of time, perhaps by using CDs or annuities, you will typically earn a currently higher interest rate than you would with more liquid and safe investments like savings accounts or money market funds.
Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we fact-check and maintain the accuracy, reliability, and quality of our content.
Federal Deposit Insurance Corporation. “Deposit Insurance in Brief.”
Federal Deposit Insurance Corporation. “The basic deposit insurance coverage has been permanently increased to $250,000 per depositor.”
Fidelity. “What are Money Market Funds?”
Department of the Treasury. “Treasury Department Announces End of Money Market Fund Guarantee Program.”
Department of the Treasury. “Treasury Department Announces Temporary Guarantee Program for Money Market Funds.”
Investor.gov. “Money Market Funds.”
National Association of Insurance Commissioners. “The Healthy Network at Work.”
The Original Article
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Source: https://www.thebalancemoney.com/how-safe-are-your-safe-investments-2388530
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