Can someone explain why all 401K funds are subject to risk while others can be FDIC insured?

[mod mom]

My friend has a SEP and said she has retirement funds FDIC insured but our 401K allows no place to federally insure even a portion of retirement funds. Can someone explain why this is so.

[nbsmom]

1. Your friend may be confused

Unless her SEP IRA is at a bank and holdings are entirely in CDs and other bank-like investments (two very big ifs), she has no more FDIC protection than you do.

She may be confusing FDIC with SIPC. SIPC is the insurance fund for brokerage entities very similar to FDIC insurance.

If there was an opportunity to 'insure' investment returns, you can imagine that some of these Nobel Prize winners responsible for credit default swaps would have already figured out a way to game that system, too.

:-(

[mod mom]

3. Thank you. I found this at the FDIC site:

Securities you own, including mutual funds, that are held for your account by a broker, or a bank's brokerage subsidiary are not insured against loss in value. The value of your investments can go up or down depending on the demand for them in the market. The Securities Investors Protection Corporation (SIPC), a non government entity, replaces missing stocks and other securities in customer accounts held by its members up to $500,000, including up to $100,000 in cash, if a member brokerage or bank brokerage subsidiary fails.

Why wouldn't they allow plans to offer a CD option alongside other options?

[Statistical]

6. they do. likely you have a fund option that buys govt debt.

check all your fund options. you will find one (very low yielding) fund that buys govt debt.

CD are issued by banks.
Treasury Bonds are issued by fed govt.

If CD goes bad it is the fed govt who picks up the tab.
Essentially when you buy a CD you are saying "I know that even if the bank goes bad my $$$ is safe because the FDIC insures it. The FDIC is safe because the FED GOVT backs it".

Buying a T-bill is just going directly to the source = fed govt.

If you friend invests in common stock then he is subject to market losses just like you.

There is nothing "special" about his SEP.

[mod mom]

9. Thank you. nt

[SCantiGOP]

2. every plan I know of

has an option of putting your account into money market funds, meaning you aren't going to make much but your principal won't go down.

[amandabeech]

17. Money market accounts are only insured by the FDIC if they are offered

by a bank, and not the bank's brokerage arm.

Money market funds or accounts offered by other entities, like brokerages, are generally very safe.

However, one, maybe two, of them went down earlier in this financial crisis. I cannot recall if there is now some special arrangement to keep that from happening while we work ourselves out of the current situation.

[peace13]

4. It is not unlikely that your friend has her retirement funds at the bank.

We did that two years ago and now even if it isn't growing much it is FDIC insured until the government goes officially broke.

[Statistical]

5. It is insured just not they way you are thinking.

There are two types of insurance.

There is insurance against fraud/embezzlement/theft.
Your 401K is insured up to $500,000 (many are insurance privately into the millions) against those types of losses.
Banks are insured via FDIC.
Brokerage accounts are insured via SIPC.

Neither protects against market losses. It only protects against account losses = fraud, theft, misrepresentation, etc.

Then there is insurance against market loss.
If you friend owns stock or corp bonds in his SEP then the loss due to market is NOT protected.

However he likely owns govt backed securities such as CD, some money market accounts, and T-Bonds (treasury).

There is no difference between your friends SEP and your 401K.
Friends SEP = insured against fraud/embezzlement/theft = $500k
Your 401K = insured against fraud/embezzlement/theft = $500k

If your friend invests in CD, money market & Treasury Bonds = no risk to principle
If you invests in CD, money market & Treasury Bonds = no risk to principle

If your friend invests is common stocks, options, or corp debt = risk to principle.
If you invests is common stocks, options, or corp debt = risk to principle.

Virtually all 401K have an option to invest in govt debt (i.e treasury bills) however you likely will have a better risk vs return taking slightly more risk and picking up high grade (non financial) corp debt.

The bad news is that secured debt currently yields are very very low.

Companies like Altria (MO), Walmart (WMT), Time Warner (TWC), Verizon (VZ), Nucor (DUE), Exxon Mobile (XOM) aren't going anywhere and their debt is low risk (although not riskless) while the return is superior to govt secured debt.

[Kolesar]

7. So, what would be the return on companies that you mentioned?

I expect that I would have to use a brokerage account to buy those in a "qualified" plan such as an IRA. My 401k has a provision where I can create an account where I can buy individual equities (and not just their list of funds). I could probably use that to buy a corporate bond.

Good explanation, by the way! :hi:

[Statistical]

12. You may need to.

The yield is always changing because bonds are resold.
A company make a primary sale when they issue a bond. i.e vZ sells a $1000 bond @ 6% for 5 years. That means it will pay $60 per year for 5 years then repay the $1000 in full. someone trades $1000 for that promise and that essentially is what a bond is.

Once issued the bonds are sold and resold on the secondary market. Lets say the guy who owns VZ bond doesn't want it anymore. He can sell it to another investor (similar to stocks) for more or less than $1000. The amount you buy the bond at, combined with amount of time remaining on the bond determines the EFFECTIVE YIELD TO MATURITY.

Make sure you completely understand how bonds work before you buy individual bonds.

Your 401K likely offers a low risk bond fund what invests in investment grade companies. The prospectus should show you the top 10 companies they own bonds for.

Remember corp debt is NOT SECURED. It can lose money however the yields often are in the 5%-10% range which is far better than <1% that insured debt is offering right now.

[Kolesar]

16. Aberdeen Core Plus Fixed Income Fund - What do you think?

What it invests in
Primarily invests in high quality fixed income securities within various U.S. market sectors. Securities rated below investment grade are permissible but limited to 17% of the market value of the portfolio. The fund may invest in foreign or domestic investments. The fund may use futures, forwards, swaps, or options as a strategy to hedge investments or as a substitute for purchasing or selling particular securities. Using derivatives involves risks which could decrease the value of the fund. Participants may experience gains or losses on their investments. In general, bond prices rise when interest rates fall, and vice versa. This effect is usually more pronounced for longer-term securities. Unit price,yield and return will vary.

Top Ten Holdings 2 as of 01/31/2009
USTN 3.75% 11/15/18
USTB 5.5% 8/15/28
FNMA 4.50% 2/37 #TBA
FHR 2991 QE 5% 8/34
FNMA 5.00% 9/33 #190340
GECMC 07-C1 A2 CSTR 4/12
USTN 4.875% 4/30/11
FHR 2802 NE 5% 2/33
FNMA 6.50% 1/38 #968811
USTB 4.5% 5/15/38
_____
I see US Treasury and Fannie Mae in there. The fund lost .62% year to date and 11% in the last 6 months. I expect that is because interest rates have been falling and affecting the discount of the bonds it holds. I don't know though. thanks!

[Statistical]

8. An example might help

My 401K is managed by Merill Lynch.

Wait ML? Wasn't there a risk they would go bankrupt??????? OH NOES OH NOES.
No worry all 401K are insured by SIPC. So if ML had gone bankrupt an illegally used my retirement funds to try and stay afloat I would be insured AGAINST NON MARKET LOSS via SIPC.

Now ML offers my company about 20 choices.

One of them is this:
Nerill Lynch Preservation Trust.

Asset Category: MONEY MARKET/STABLE VALUE

Trust Objective: This is a collective trust maintained by Merrill Lynch Bank & Trust Co., FSB to which BlackRock Investment Management, LLC provides nondiscretionary investment management advice.

Portfolio Concept: The Trust seeks to provide preservation of capital, liquidity and current income at levels that are typically higher than those provided by money market funds. The Trust invests primarily in a broadly diversified portfolio of Guaranteed Investment Contracts (GICs, including BICs, synthetic GICs and separate accounts) and in high-quality money-market securities.

Results for Month Ending February 28, 2009.
Total Return Average Annual Total Return
Qtr YTD 1 Year 3 Yrs 5 Yrs 10 Yrs Since Inception
0.18% 0.42% 4.09% 4.53% 4.43% 5.09% 5.93%

Now it is insured debt however look at that yield. YTD it has returned 0.42%. Last qtr it returned 0.18%. So you can expect to make about ..... 0.18% *4= 0.72% for the year.

If you look at the 1yr, 3yr average return you will see it yielded higher in the past but right now there is a huge flight to quality which is pushing yields down to essentially 0%. This isn't limited to just this fund, all "no risk" or "low risk" options are returning essentially 0% (actually <0% when you look at real $ after inflation).

[mod mom]

10. Thank you. very informative.

[DeschutesRiver]

13. oops, duplicate post

..

[DeschutesRiver]

14. From the SIPC website - they DO NOT provide insurance for investment fraud

From the SIPC website at http://www.sipc.org/who/notfdic.cfm:

Why We Are NOT the FDIC
"Insurance" for investment fraud does not exist in the U.S. The Federal Trade Commission, Federal Bureau of Investigation, state securities regulators and other experts have estimated that investment fraud in the U.S. ranges from $10-$40 billion a year. In the case of microcap stock fraud, the toll on investors has been estimated as $1-3 billion annually.

With a reserve of slightly more than $1 billion, SIPC could not keep its doors open for long if its purpose was to compensate all victims in the event of loss due to investment fraud.

It is important to understand that SIPC is not the securities world equivalent of FDIC–the Federal Deposit Insurance Corporation. Congress specifically considered creating a Federal Broker-Dealer Insurance Corporation, but lawmakers wisely concluded that such a designation would be both misleading and out of step in the risk-based investment marketplace that is so different from the world of banking.

It is frightening to contemplate the full rammifications of the above quoted statement from SIPC, given what is currently going on. In fact, dh and I watched a show on Fox of all things last night where they met with and took questions/comments from Madoff victims. It was disturbing to realize that many of us simply don't understand our investments or the insurance provided. Our IRAs/SEPs are with brokerages, because they have to be held by a "custodian". But if that custodian commits a fraud, where happens to our retirement? In last night's special, they made a point of saying that the SIPC had "agreed to extend coverage" to the Madoff victims as appropriate, ie they did not have to do so. I assumed due to the fraud.

Also, one Madoff situation involved 140 people who invested with a FA, who invested it all in one account with Madoff - the SIPC is treating all 140 as one single 500,000 claim, not 140 individual claims. I didn't catch the specifics which the SIPC thought allowed them to count all those investments as a single one, and would like to see a repeat of the program. It was 2 hours and stunning in the disclosures. William Pitt, former SEC dude was there, and he was a weasel.

[newfie11]

11. Back before the shit hit the fan I moved most of my retirement money

It is in a money pension purchase plan with TD Ameritrade. For years I self directed where the money was invested (I like stocks not mutual funds).
When I retired in 2005 I sold all the stocks with a few exceptions and moved the rest into a money market. I could have done this at any time as I was self directing where it went but the money market of course is not great at making money.

I was told by TD Ameritrade that this money in the money market is FDIC insured.

Maybe this is what your friend has done.

[OHdem10]

15. Just like everhing else, and Pres. Obama has explained. The system.

is designed to protect the affluent at the expense of all others.

Chnage is a formidble task.

The very idea that Baucus is ready to tax Middle Class HealthCare
rather than ask the rich to give up their deductions--is perfoect
proof.

Reagan had the initial cut off in SS at 93,000. His attitude was.
"The Middle Class want this benefit--let them pay for it."

Every piece of legislation since R. Reagon has been to advantage
the upper class . Unfortunately , it has often hurt the Middle
Class and has put us in the ditch.