Personal Finance

Robinhood debate highlights the difference between FDIC and SIPC protection

Key Points
  • Robinhood, an online stock trading app, debuted new accounts this week that take aim at checking and savings accounts.
  • The launch drew criticism and ignited a debate over whether SIPC versus FDIC coverage is best for investors.
  • Advisors urge all consumers to know what the terms are before they get lured in by the promise of higher rates.

If you want to park your money in a safe place amid current market volatility, there's one thing you absolutely need to do.

Check what kind of protection the financial institution holding your money has.

This bubbled up as an issue this week on the news that Robinhood, an online stock trading app, announced that it plans to offer accounts that would compete with the checking and savings accounts offered by banks.

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The news caught the eyes of many for one reason: Robinhood is promising 3 percent interest, a return unheard of since the financial crisis because the Federal Reserve has kept rates low.

But there is a key difference between investing with Robinhood and your typical bank offering traditional checking and savings accounts.

Here's the fine print: Robinhood states in its disclosures that it is covered by the Securities Investor Protection Corporation, or SIPC, a nonprofit membership corporation. Banks, meanwhile, are covered by the Federal Deposit Insurance Corporation, or FDIC.

And the distinction between the two could make a big difference in how much you get back if something were to happen to the financial institution with which you've invested.

FDIC vs. SIPC

If your bank is covered by the FDIC, your money is insured for up to $250,000 per depositor. And if you have money parked with another financial institution covered by the FDIC, you are also covered for up to $250,000 there.

That means if the financial institution you're banking with fails, you will get your money back. If your bank fails, you will get refunded dollar for dollar the money you put in, plus interest up to the date the institution went under.

In contrast, if your institution is a SIPC member, you do not get the same level of coverage. If something happens to your brokerage firm, you are covered for up to $500,000, with a $250,000 limit for cash.

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Robinhood now offering checking and savings accounts, interest rates at three percent

That might not sound like a bad deal. But there are limitations.

SIPC protection is not the same as FDIC coverage because SIPC does not protect the value of any security, SIPC states on its website.

SIPC will not protect you if the value of your securities declines. It also does not cover you if you were sold worthless investments, received bad advice or were steered toward investments that are inappropriate for you.

What you should know

Robinhood's news this week inspired a Twitter debate over FDIC versus SIPC coverage.

And the most vocal critics of the limitations of SIPC coverage were financial advisors.

Jude Boudreaux, partner and senior financial planner at The Planning Center, was one of them.

Without more detail on Robinhood's accounts, Boudreaux said there's "no way" he would recommend a client invest with them.

"We're taking a lot of unknown risk here for, honestly, not a lot of extra returns," Boudreaux said.

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While it's not the Great Depression, there are still banks that are forced to shutter, he said. And the good news for investors when they're FDIC-insured: They will get their money back.

If, however, that account is SIPC-covered, investors may only get a percentage of their money back. They could also be subject to a lengthy dissolution process.

To help frame decisions, Boudreaux talks to his clients in terms of small mistakes versus big mistakes.

"It's a small mistake if you don't get every penny of interest you could on a deposit," Boudreaux said. "But it's a big mistake if we put those true cash deposits in a place that we don't know anything about and something happens."