Stock and ETF Insurance

Can You Buy Insurance To Protect Your Investment?

There are several ways you can protect yourself against market declines with “insurance”. The question is should you buy this kind of coverage and if so what is the best method to do so?

As I hinted above, you can protect yourself from nasty stock market spills in any number of ways. Of course one option is to keep your money in cash. If you do that, you never have to worry about the market. You may have other problems that are far worse of course, like never being able to retire.  But at least stock market declines won’t keep you up at night.
Other than parking your money in cash, there are two popular alternatives that some investors use to protect themselves against the downside of investing in the stock market.

The Federal Deposit Insurance Corporation (FCIC), which sums up its main job: to insure your deposits. It does this not by charging you premiums like with your other insurance policies, but by charging the banks that it regulates. This means all banks but not all bank-like financial entities. If you’re in a bank like Wells Fargo, or a local bank like “First State Bank”, or a credit union set up by your employer you can rest assured: the FDIC has your back (and your bank).

In the event of a bank failure (like the one that gripped my credit union a few years ago), the only thing likely to change, from your perspective, is the logo on the branch. My credit union went belly-up after making some loans to Florida developers that the developers were unable to repay. When the credit union ran out of money, the FDIC came knocking on a Friday night after closing. By Monday, they had sorted everything out and transferred ownership of the bank to another credit union willing to take it over. The new credit union got the old one’s assets, and if they weren’t enough to cover the liabilities then the FDIC covered them.

There is one major caveat: if you make an investment through a brokerage or financial planner, that brokerage may have the Securities Investor Protection Corporation(SIPC) coverage. The acronym even looks a bit like FDIC, so is it similar?
Yes and no. It does provide a measure of insurance, but only in very special cases: if your brokerage goes bankrupt and its remaining assets are unavailable then the SIPC will help to retrieve them and return them to investors. Critically, you the investor still bear any market risk.

An example might make this more clear. If you invest through a brokerage in 10 shares of Apple stock, and Apple stock craters, the SIPC cannot help you. However, if your brokerage goes bankrupt after the Apple stock craters, then the SIPC can help you recover your 10 shares–but they will only be worth what they’re worth on the market, not their original value.

In real life, the SIPC has helped to return part of the money that Bernie Madoff collected through his fraudulent activities. Unfortunately, only a bit more than half has ever been found–showing the limits of the SIPC.