“What is safe money?” That is a question that many Americans are asking. And it’s not surprising why. From retirement presentations and dinner seminars to weekend financial talk shows and radio commercials, safe money is a common theme in many public forums.
Generally speaking, a broad definition of safe money is “the money you can’t afford to lose.” Since everyone has different needs, goals, and situations, this concept means different things to every person. For some, safe money could be lifelong savings they have built up and need to preserve. Or it might be accumulated wealth that needs to be protected from risk, as it will be a source of retirement income.
For others, it could be a stockpile of money they will need at a certain time, like funding their children’s college education, paying off the mortgage, or buying a luxury item for which they saved a long time. Yet for some other Americans, safe money might be a future account balance – a sum of money that they want to grow safely and efficiently.
So, the answer to “what is safe money?” is it depends. Your own needs, goals, and situation provide the financial context of its meaning. But boiling down to the essentials, safe money is about security and protection… money that is safe and as free from unnecessary risk as is possible.
What are Some Safe Money Options?
As the equity markets soar to new highs, many investors are looking for ways to preserve their portfolio gains. For those with a more conservative risk tolerance, the options can be slim. When safety of principal is a priority, a few choices provide “guarantees” of keeping your principal intact. In fact, even fewer options provide those guarantees and still offer better growth than the instruments earning paltry interest, like savings accounts and money market funds.
These few choices include:
- U.S. Treasuries, backed by the U.S. government
- Certificates of deposit (CDs), issued by banks and protected under the FDIC
- Fixed annuities, issued by insurance companies and regulated by state insurance bodies
While these organizations guarantee principal protection, their assurances are only as good as their ability to uphold them. And there is a trade-off for putting money into these instruments. So, before going into more detail, let’s discuss some potential demerits associated with these options. If ensuring monetary safety is so simple, why would people consider other places to park their money?
One likely reason is growth potential. Even though these three options come with a high degree of safety, their capacity to earn interest is limited compared to elsewhere. In retirement and money matters, a good rule of thumb to remember is the “safer” an investment, insurance, or deposit option is, the lower its growth potential will be.
So, people may be attracted to higher-risk options like stocks, mutual funds, variable annuities, and real estate assets because of their higher potential for growth. Now, back to the discussion of these different safe money options – just how strong are their guarantees?
Since they are issued by the U.S. Treasury, Treasury bills, notes, and bonds are backed by the government’s “full faith and credit power.” These securities have the support of the federal government’s ability to raise taxes, print more dollars, and use other measures at its disposal. In exchange for “lending” your money to the government for a specific duration, you are promised the return of your principal and some earned interest.
Because Treasuries aren’t backed by contracts or assets, but rather federal powers of currency, these securities offer a high degree of safety. However, they are vulnerable to “interest rate arbitrage,” or the risk of losing value with interest rate movements. When interest rates rise, underlying bonds tend to drop in value. Treasuries with a longer duration may be more affected by interest rate risk. As a result, they may be more at risk for value declines.
Also, because of the safety of their guarantees, Treasuries tend to come with lower interest rates than other fixed-income options. One upside? They can be exempt from local and state income taxes, but federal income taxation does apply to them.
Bank Issued Certificates of Deposit (CDs)
Certificates of Deposit (CDs) issued by the banks also enjoy principal protection. They are covered by the Federal Deposit Insurance Corporation (FDIC), which actually isn’t a governmental entity. Rather, the FDIC is an independent “insurance” agency created by Congress to maintain the stability of the U.S. banking system. As an independent organization, the FDIC insures deposits in banks and thrift savings institutions. Its standard deposit insurance coverage is any amount up to $250,000 per depositor per insured bank, for different types of account categories, including CDs.
The FDIC receives no funding from Congress, but rather from banks and thrift savings institutions nationwide for deposit insurance coverage. Earnings on investments in U.S. Treasuries also go toward its operations.
On its website, the FDIC says that “since the start of FDIC insurance on January 1, 1934, no depositor has lost a single cent of insured funds as a result of a failure.” Note, if bank failures were catastrophic and FDIC reserves underwent a strong enough shock, the FDIC could leverage a $100 billion credit line with the U.S. Treasury, as well as the “full faith and credit power” of the U.S. federal government.
An important thing to note is the reserve requirements which banks must meet. According to the Federal Reserve, currently banks must maintain a 3%-10% ratio of reserves to total liabilities, or money they give out to borrowers. That is $0.03-$0.10 for every $1.00 in total liabilities. So, when you have money parked at the bank, you depend on the bank’s ability to maintain its deposit requirements. And should a bank fail, depositors would depend on the FDIC’s ability to cover their insured funds.
Fixed-type annuities, or just fixed annuities, are also considered to be a “safe haven.” Unlike the prior two options, fixed annuities aren’t backed by assets or federal power of currency, but rather contractual guarantees. Insurance companies pledge to cover premiums paid into fixed annuities with dollar-for-dollar reserves. More on that in a little bit.
- Fixed deferred annuities
- Fixed index annuities
- Multi-year guarantee or fixed-rate annuities
Overall, fixed-type annuities can offer three benefits. First, as annuity products, they are the only instruments which offer “guaranteed” income for your remaining lifetime or for a certain period. Second, the insurance company protects your principal in the contract, with certain conditions. Third, the insurance company can offer a minimum rate of growth for your premium, in the form of interest being credited to your contract. Because interest is being directly applied to the contract value, the value of your money won’t decline from when equity markets fall.
Note, the guarantees of an insurance company depend on its financial strength and its claims-paying ability. One way to judge this is to look at company ratings from sources such as A.M. Best and Standard & Poor’s. In A.M. Best’s framework, company ratings range from A+ to D. This signifies a rating from Superior to Poor. Companies receiving statuses below those are impaired or have had their company status suspended.
Another thing to watch out for is the insurance company’s solvency ratio. State insurance departments regulate all of the carriers and maintain strict standards. Part of these regulations is insurance companies must maintain dollar-for-dollar reserves for every dollar in premium they guarantee. So, for every $1.00 of premium pledged, the insurance company must maintain a $1.00 in reserves — unlike the lower $0.03-$0.10 reserve requirements for banks. Most insurance companies, in fact, maintain above the dollar-for-dollar requirements, and this is where the solvency ratio kicks in. If a carrier has a solvency ratio of 106, they maintain $1.06 in reserves for every premium they promise to contract and policy owners.
These levels of surplus capital are definitely something you should confirm if you are considering annuity options for your portfolio. To learn more about the reserve requirements of insurance companies, you can find more helpful information in a free personal copy of Annuity Insights Guidebook.
Final Thoughts on Safe Money
So, the answer to “what is safe money?” is it depends on the context of your complete financial picture. And yes, there are options offering guarantees for protection of your principal when you are retired or near retirement. While nothing is failproof, these choices can offer a high degree of protection and security. If you are interested in discovering ways to protect your money, generate a reliable income month-to-month, and enjoy a comfortable lifestyle, financial professionals at SafeMoney.com can help you.
Use our “Find a Financial Professional” section to connect with someone directly. And should you need a personal referral, call us at 877.476.9723.