If you have any amount of money deposited in a financial institution, you definitely want some insurance on your funds. History has shown many times over that deposits can up and vanish if they’re not protected.

SIPC Protection

If you’re wondering if brokerage firms in the United States offer FDIC insurance, the answer nowadays tends to be both yes and no. Years ago, the answer was no. To gain a correct understanding of how insurance works in the brokerage world, it’s best to start with the older situation.

The U.S. Congress understood the need to have insurance for brokerage accounts, so it created SIPC in 1970 (technically, it is Congressionally mandated). SIPC is funded by member brokerage firms, and it protects the number of shares in an account up to $500,000. Half this figure can be applied to cash balances.

Notice that we said “number of shares.” If the price of your stock goes down to $0, SIPC protection doesn’t give you anything because $0 times a billion shares equals $0. It doesn’t insure the share price. If it did, investing would undergo a revolution because there would be no more risk. Not likely to happen anytime soon.

FDIC Protection

The FDIC only protects bank accounts, but we mentioned that some broker-dealers today offer some FDIC insurance. How exactly do they do that? They build partnerships with FDIC-insured banks and use them for their customers’ free cash balances. These are called FDIC sweep programs. Brokerage firms literally move any uninvested cash in their customers’ accounts to these banks, where the cash earns interest and is protected by the FDIC.

One really nice advantage of this system is that brokerage houses can use multiple banks. If they do (not all of them do this), you’ll get more than the FDIC’s standard $250,000 of insurance. Fidelity, for example, uses five program banks, and this results in $1,250,000 of insurance for cash balances per brokerage account holder.

Other investment firms, like E*Trade and Schwab, actually own their own banks, and they are members of the FDIC. So E*Trade’s and Schwab’s bank accounts (not brokerage accounts) carry FDIC insurance. But there’s no sweep program. They’re not going to move uninvested cash to a rival bank. They use a percentage of their deposits for their operations.

Supplemental Insurance

If you have more than SIPC’s standard $500,000 to invest, some brokerage firms offer supplemental insurance to cover the amount above that level. Vanguard, for example, offers extra insurance from Lloyd’s of London and London Company Insurers. This policy has an individual limit of $49.5 million for securities and $1.75 million for cash. The maximum the policy will pay for the whole brokerage house is $250 million. The supplemental policy kicks in only after SIPC protection has been maxed out for an account.

Because Vanguard has over $5 trillion in client assets, the supplemental policy doesn’t look very large; but it is there if it’s ever needed. Some of the smaller brokerage firms have no supplemental insurance at all.

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