How FDIC Insurance Works

Effective cash management strategy lays the foundation for the success of any financial plan. With a good cash management plan you can preserve liquidity and collect interest to make timely bill payments, save up for big-ticket items, and set money aside to purchase investments. As part of any cash management plan, it is important that you understand how FDIC insurance works. The government provides FDIC coverage to guarantee banking deposits and preserve the stability of the financial system.

FDIC Insurance: Identify Banking Deposits

Again, FDIC insurance effectively guarantees your principal deposits and interest payments earned at banks doing business within the United States. The FDIC defines bank deposits as certificates of deposit alongside checking, savings, and money market accounts. FDIC insurance, however, does not guarantee investments, such as stocks, bonds, and mutual funds.

Be advised that a money market mutual fund is separate from a money market deposit account. A money market mutual fund is an investment product that holds money market assets, such as commercial paper and treasury bills. A money market mutual fund is therefore NOT covered by FDIC insurance.

FDIC Insurance: Coverage Limits

As of 2010, the FDIC guarantees $250,000 per customer, per bank. As a large depositor, you will divide a lump sum of cash between several different banks to insure the whole amount. For example, you would divide $600,000 into six separate $100,000 deposits at six different banks to maximize your FDIC coverage. If you were to put the entire $600,000 balance into one account, you would leave $350,000 without insurance.

FDIC Insurance: Risks Versus Rewards

In exchange for safety of principal and interest, you must be willing to accept relatively minimal returns on bank deposits, if any. Banking deposits are therefore exposed to both inflation and interest rate risks. Inflation describes rising prices for goods and services, which erode the future purchasing power for cash. According to the U.S. Bureau of Labor Statistics' Consumer Price Index, domestic inflation runs at a 3 percent average annual clip each year. As a saver, interest rate risk relates to times when prevailing interest rates move higher. For example, you may take out one five-year CD that locks you into a 4 percent interest rate. This return would look even more paltry, if rates were to rise over the next year and five-year CDs began paying out 7-percent interest.

FDIC Insurance and Investment Strategy

You will create a diversified portfolio of bank deposits, bonds, and stocks to manage financial risks and invest for growth. In all conditions, FDIC-insured bank deposits will provide for liquidity, or quick access to cash. Meanwhile, you can grow your portfolio through interest income, dividend payments, and capital gains upon your stocks and bonds. The SEC recommends mutual funds for beginning investors. Each mutual fund share features asset rights above a larger asset pool of hundreds of different securities.

How FDIC Insurance Works, Sources:

FDIC: Deposit Insurance Summary

FDIC: Insured or Not Insured

SEC: Invest Wisely - An Introduction to Mutual Funds

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