Warren Buffet, the “world’s great investor,” lost $11 Billion last year. His famed fund, Berkshire Hathaway, was down 10.5% in 2015.
Sure, you and Warren Buffet are well aware that building – and even maintaining – wealth in the stock and bond markets is a long-term proposition. You’re no stranger to drops in the stock market of a meaningful magnitude (think 1973, 1987, 1989, 1990, 2000, 2001, 2008, now 2015), but you’re still not a fan of seeing losses on your statements, right? Yeah, me neither. “But there has to be something we can do to steer clear of these events,” cries every investor ever.
In this brief look at financial tools available to you, I’ll highlight some notable pros and cons of various investing options that may be worthy of a closer look, if you’re losing your love for the stock market.
Short or Inverse Stock Mutual Funds / Exchange Traded Funds / Index Funds
In most discussions, I will not lump mutual funds, exchange traded funds (ETFs) and index funds together because of a number of meaningful differences. However, in this case, I’d like to focus on one particular option that is commonly available with all of these types of funds. A portfolio comprised of several to many of these investment cousins allows a person to own a very diversified portfolio of companies that will grow in value as the general economy grows. Typically, this approach is an investor’s chance to receive their “fair share” of the gains the market has to offer…and the losses. Going “long” in an investment means you’re choosing ownership in the investment in hopes of long-term growth.
The same type of funds described above sometimes offer options to “short” a company or sector of the economy. If you think the financial sector is poised for a decline, you may buy a fund that takes an inverse or short position to that sector. That way, if the sector loses value, and you sell your fund at the right time, you can earn a return from that fund’s growth in value. The problem with this approach is that statistically, the market and individual sectors trend upward in value more often than they decline. This adds a significant amount of risk to the strategy, so you’d better have your timing right.
Fixed Indexed Annuities
While there are many different types of annuities, including fixed annuities and variable annuities, the fixed indexed annuity offers attributes unique to the other choices. A fixed indexed annuity is a type of annuity that grows at the greater of a) an annual, guaranteed minimum rate of return; or b) the return from a specified stock market index (such as the S&P 500®), reduced by certain expenses and formulas.
This means the owner of the fixed indexed annuity (FIA) is able to participate in much of the gains when the stock market rises, but when the market falls, there is a floor in place that prevents the account from losing money. In other words, it only has the potential to grow, not to decline. This creates a scenario for an investor to win without the possibility of loss, assuming certain guidelines are met.
The FIA has gained dramatically in popularity the last few years because of its unique attributes. While we have used these products extensively for income planning, options for building a “safe accumulation” strategy, in lieu of keeping money exposed to market losses, may be worth considering. These products are guaranteed by the insurance companies who issue them.
CDs or Cash
Let’s face it, cash and bank certificates of deposit (CDs) look really good when the alternative is a shrinking stock and bond portfolio. For money that is needed for essentials within the near term, this is where it should be parked. As with all investing and savings options, there are strings attached. The glaringly obvious strings attached to cash and near-cash is the painfully low (or no) interest received while the money is stored. The proper balance of cash to risk-based investments is solved through holistic planning of all of your financial assets and goals.
Why not Bonds and Bond Funds?
While stocks and stock funds represent ownership in a company, bonds are the means by which people loan money to a company or municipality. A bond pays an interest rate for the use of the money, and bonds mature at a pre-determined date in the future, giving the bond owner her money back at maturity. Historically, bonds have been viewed as the safe alternative to owning risky stocks. Bonds are often more stable because of the stated interest rate and maturity date, allowing bond owners to better predict their ownership experience. The problem? In the current economic environment, interest rates are extremely low (look at the interest you earn on your savings account at the bank). Because a person looking to buy a bond is buying that stated interest rate on that bond, a rise in future interest rates results in current bonds to be worth less when sold in the future. Thus, bonds are not nearly as “safe” as they once were because of declining bond values in this rising interest rate environment.
While bonds are very susceptible to rises in interest rate, don’t rule them out entirely. Like everything else, some diversification among bond types is necessary for building a proper portfolio. My point here is that moving everything to bonds may provide some relief from losses in the stock market, but bonds have their own struggles in the months and years ahead.
What To Do Next
If…and I mean IF you’re having a difficult time stomaching the turmoil that is our current stock market, there may be some options to consider. In some cases, it may make sense to secure some of your at-risk investment assets in a fixed indexed annuity, and there’s always reason to hold some cash on-hand. As for shorting the market with inverse and short funds, that’s a very challenging option to time right.
Please respond to this email if you’d like to talk about any of these options, or any others that you may have read about. Times are certainly challenging, but solid planning and keeping options open may be the relief you need to stay the course.
All the best,
Adam Cufr, RICP®
