Your Investment Portfolio: Are You Protected in an Economic Crisis?

By Martin Brown

During this panic in the financial markets, one nightmare scenario that keeps waking investors out of a sound sleep is the thought their money will suddenly vanish if their brokerage house fails. Not long ago, you may recall, the Federal Reserve and the Treasury stepped in to save the investment house of Bears Sterns, which was forced into the arms of its competitor, J.P. Morgan Chase. But in September, when Lehman Brothers failed, the Fed took no such rescue action. Lehman was broken apart into various pieces and dissolved.

That leaves the average investor to wonder, “What would happen to my investment portfolio if my brokerage house was to fail?”

Enter a Federal program called the SIPC.

A lot of people are hearing about now for the first time, but it has been in business since 1970. Most of us have heard of the FDIC, the Federal Deposit Insurance Corporation. The SIPC—the Securities Investor Protection Corporation—guarantees the safety of your invested assets up to $500,000. And if you were invested with two brokerage houses, that protection would double.

Now, keep in mind that up until this financial crisis,  in its 38-year history the SIPC has had to spend a tiny sum, $508 million, to recover customer’s assets, as opposed to the trillions of dollars that has been invested by Americans in various brokerage houses. That does not mean serious concerns are not legitimate. It only illustrates the relative rarity of a brokerage house failure that involves fraudulent behavior.

Two important points that you should keep in mind:

1. The losses in your portfolio are not covered.
All that means is if you bought Google at $550 a share and today it’s worth $325 a share, that’s your loss. You made a bet the stock would go up and just like any bet you have to accept the outcome of the risk.

2. Brokers as a general rule, follow what you might think of as “the dry cleaner’s code of ethics.”
In other words they handle your money, but you won’t find them wearing your favorite dress to a wedding reception. If the dry cleaner goes out of business, your garments should still be there. A broker handles your investment portfolio, they don’t use it for their own purposes unless, of course, they have acted fraudulently.

This is why that, in the event your brokerage house does fail, your investments should be transferred into another house. It’s not your money that has gone away, but  your investment house. The stocks and bonds you purchased should remain at whatever there value was prior to your brokerage house closing.

As a general rule ,the protection of the SIPC only becomes a factor when fraud has been committed: for example, if the investment you thought you made in the XYZ Equity Fund only existed on paper and is not really there.

And this happens with the same frequency as if you were to go to a reception, only to see the fabulous dress you bought being worn by the drycleaner’s daughter.

If you’re wondering exactly what coverage is provided by the SIPC, you can get the full details by going to http://www.sipc.org/.

Don’t forget that financial panics are driven more by myth and ignorance than hard facts. What we have all been seeing in the past few weeks is just that. It’s time to arm yourself with knowledge. It won’t necessarily turn your investments around overnight, but it will help you sleep much better.

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