There Are Some Investments You Can’t Bank On

Do you know how safe your bank investments are? According to a newly released national survey, the answer is probably not.

More than half the people who buy mutual funds and annuities through banks wrongly assume that these investments are protected by federal deposit insurance. Another 35% of those who buy individual stocks through banks think their principal is federally insured, according to the survey commissioned by the North American Securities Administrators Assn. and the American Assn. of Retired Persons.

Ironically, a great deal of the problem may be semantics.

Consumers don’t differentiate between the terms federally insured , insured and guaranteed , says Marcia Selz, president of Marketing Matrix, a financial services research firm in Los Angeles. And they are particularly likely to misunderstand--even with a clear disclosure document--when they are standing in a bank branch where years of experience has told them they can’t lose any money, she adds.

In fact, you can lose money on “government-guaranteed” and “insured” investments because, in the complicated realm of finance, different guarantees have different meanings.

For instance, bank deposits are “federally insured” and “guaranteed” by the federal government. That means that if your bank fails, a representative from the Federal Deposit Insurance Corp. will show up with a checkbook, ready to pay you virtually on the spot the amount in your account, up to $100,000.

No matter when you take the money out, the dollar value of your savings account cannot decline. It can only increase as interest accrues. This is generally what people picture when they hear “government guaranteed.”

On the other hand, if you buy a mutual fund that invests in government-guaranteed securities, such as Treasury bonds, your guarantee means something else entirely. A Treasury bond is a long-term IOU from the federal government. And the U.S. government has issued a blanket guarantee that it will pay back every dime it borrowed, with interest.

But the value of your mutual fund account--even if it is invested solely in government-guaranteed bonds--does not slowly rise like the value of your savings account. The value of this investment rises and falls with the going market price for the bonds.

How could a government bond be worth less than what you paid? If inflation or interest rates rise, the market value of bonds drops because investors have better options. In other words, why pay $1,000 for an old Treasury bond that pays 6% interest when you can get a new Treasury bond that pays 7%? If you want to sell that 6% bond, chances are you could only get $900 for it today.

The fact that the government will eventually pay back the full $1,000 does nothing to compensate you for your $100 trading loss.

Stock investments also boast some insurance. In the event of a brokerage failure, the Securities Industry Protection Corp. will step in to guarantee payment of cash and securities of up to $500,000 per account. (Only $100,000 can be in cash.) Does that mean you can’t lose by buying stock? Hardly.

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The SIPC guarantee is really a guarantee against fraud. Let’s say your brokerage fails after a broker takes off with all the cash and securities held in customer accounts. If you can show that you had $50,000 in cash and 200 shares of IBM stock, the SIPC will step in and make sure that the cash and securities you entrusted to that brokerage firm are returned to you. But the SIPC does not protect you from bad investment decisions. If you bought IBM at $120 and it now sells for $60, the SIPC isn’t going to compensate you for your $60 loss.

Annuities are also insured, but not by the federal government. Insurance products are backed by state-run guarantee associations that generally promise to compensate you for all or part of your loss in the event your insurer fails. It’s impossible to generalize about insurance guarantees, however, because the guarantees vary based on the type of insurance product you buy and where you live.

Some state-guaranteed funds promise to pay up to $100,000 on annuities and up to $300,000 in death benefits. Others guarantee more--or substantially less.

But even the best insurance guarantees are less attractive than the guarantees for bank deposits. That’s because insurance guarantee funds generally do not have the money to pay you right away.

If your insurer fails, they will step in and try to determine the total loss. Next they’ll contact other insurers still operating in your state and ask them to kick in some money to pay you off. Healthy insurers agree to do this because they want people to feel safe about investing in insurance products. But the payoffs don’t come quickly. In many cases, such as when Executive Life Insurance Co. failed three years ago, it takes several years for customers to get their money.