Brokerage account insurance: is your account secure?

Here’s how to check if your brokerage account is insured and how much insurance you have for your assets. Image source: Getty Images

Here’s how to check if your brokerage account is insured and how much insurance you have for your assets.

By the end of the 1960s, stock prices were crashing and brokerage houses were teetering. Americans were beginning to lose faith in the financial markets and the brokerage firms that held their assets, so the Securities Investor Protection Corporation (SIPC) was created to insulate investors from the risk of a brokerage going bankrupt.

The SIPC was designed as a safety net, a form of brokerage account insurance that protected client assets in the event of the bankruptcy of a member brokerage. Since then, the SIPC has helped investors dodge billions of dollars in potential losses. But there were a few losers – the SIPC does not provide an unlimited amount of insurance and not all losses are covered.

Here’s what you need to know about the insurance that protects your brokerage accounthow it works and some historical data on past losses so you can get a good idea of ​​the risks of hosting your assets with a brokerage firm.

SIPC Insurance Limits

The SIPC is to the investment industry what the Federal Deposit Insurance Corporation (FDIC) is to the banking industry. The SIPC offers up to $500,000 of protection, which includes protection of up to $250,000 in cash. SIPC member brokerage accounts are entitled to their own $500,000 protection when they have what is called “separate capacity”.

The limits of SIPC insurance are best explained by way of example. If you have two traditional IRA accounts at the same brokerage, those accounts are combined and are only eligible for $500,000 in total protection. However, if you have a Roth IRA and a traditional IRA at the same brokerage, each would be entitled to $500,000 of protection, since a Roth and a traditional IRA are technically different.

Similarly, if you have a brokerage account in your name and a joint brokerage account with your spouse, each would be eligible for $500,000 coverage on their own. If you and your spouse also have a custodial account for your child, that account would also qualify for a separate limit of $500,000. Thus, an individual, joint and custodial account at the same brokerage would qualify for total protection of $1.5 million ($500,000 each).

Theoretically, you could split your money between different brokerages to maximize SIPC protection, although the administrative work of managing multiple accounts isn’t worth it, given the rarity of brokerage losses. Many brokers also carry insurance that extends beyond the SIPC limits, so most investors are very well protected.

What the SIPC does and does not cover

SIPC protection largely covers assets that you might typically use a brokerage firm to invest in, including “stocks, bonds, treasury securities, certificates of deposit, mutual funds, mutual funds money market investments and certain other investments,” according to the SIPC website.

Notably, it does not cover more esoteric investments. The SIPC writes on its website that futures contracts, fixed annuity contracts, foreign exchange transactions, and other investment contracts (it uses limited partnerships as an example) are generally not eligible for protection.

Realistically, virtually everything that the vast majority of individual investors are likely to own is covered by SIPC when their broker is a member of SIPC.

That said, SIPC protection is not a catch-all form of financial isolation. If your stocks lose 50% of their value due to a deep recession or poor stock selection, the SIPC will not insure your losses. Likewise, if someone promises you that an investment will return 20% per year, but it will only return 5% per year, the SIPC will not help you either.

The SIPC is there only to insure the losses of a member firm in liquidation, not to insure you against bad stock picks or promises made by a financial adviser. You can check if your broker is a member of the SIPC on his website (most surname brokerages are members).

How SIPC Insurance Works in the Real World

Let’s say you have $10,000,000 of SIPC eligible assets (stocks, bonds, etc.) in your brokerage account. Your broker is having a hard time because he made a few bad billion dollar trades with some clients’ money that he mismixed with some of his own money. The SEC, FINRA and SIPC intervene and the liquidation process begins.

In an extraordinary event where the SIPC must intervene to protect investors in liquidation, only 95% of clients’ assets may be immediately recoverable. Thus, the recoveries would bring in $9.5 million to the investor. The SIPC would pay an additional $500,000, the maximum of its limit, to cover the investor’s $500,000 loss. In this case, the investor who had a $10 million brokerage account would have lost nothing, receiving $9.5 million from brokerage liquidation recoveries and $500,000 from SIPC to cover the shortfall. to win.

But suppose the investor only received $9 million from the asset liquidation and $500,000 from the SIPC. Did they simply lose the remaining $500,000 not covered by collections and SIPC insurance as a result of their broker’s misbehavior? Probably not.

In fact, most brokers have protection known as “SIPC Excess Insurance” which covers losses beyond SIPC limits. At TD Ameritrade, for example, clients have up to $151.5 million of protection beyond SIPC limits, up to $500 million for all TD Ameritrade account holders. Ally Invest customers have up to $37.5 million in protection beyond SIPC limits, up to $150 million for all of its customers. I could go on and on, but most brokers buy this excess insurance as an inexpensive way to give their clients peace of mind in the worst case scenario.

Of course, to get to the point where the losses eat away at the broker’s required regulatory capital and SIPC limits, things would have to go very, very badly. For the losses to then consume all of a broker’s excess SIPC insurance… well, things would have to go almost unbelievably bad.

To put things into perspective, the SIPC wrote in a recent annual report that of 767,300 claims since its inception, only 356 were for amounts in excess of its protection limits. In other words, only about 5 out of 10,000 clients who actually had to make a claim (which in itself is a very small percentage of the total investor population) suffered losses greater than what the SIPC covers. Lloyd’s of London, which is the insurer behind most excess SIPC policies, is unlikely to have to pay many claims.

The short story is this: there are many ways to lose money as an investor — betting on stocks you’ve heard about at cocktail parties, buying stocks presented to you in spam emails, etc — the risk of loss due to brokerage bankruptcy is so low that it rounds to almost zero.