Stock markets are naturally volatile. You can easily lose 20% or more of your money in a hurry. That’s not fun, but it is something you can plan around. Don’t put all your money into stocks, especially if you need to make a withdrawal. Add some high quality bonds. But at some point, you have to accept a certain level of volatility to achieve higher returns.
Some people seek to have it both ways. They want to participate in the upside of stocks but also use a financial product to limit the downside. This comes in many different forms – index annuities, buffered ETFs, mutual funds or separate accounts with options strategies, etc. The offers seem attractive, but the cost is higher than you think.
A prospect came to see me recently. He had been sold an annuity that offered a floor of 0% on his investment. He couldn’t lose money. In return his upside was capped at 13.5%. That sounds really good, right? The average return on the S&P 500 is 10.4% going back to 1926 (through 09/2024). You should keep up pretty well, on average, and you’re never going to have a down year.
This annuity, bought almost two years ago, is up 9.85% per year. Again, that seems good. The return of the S&P 500 index? 25.02% per year! Ouch!
People forget that stock market returns tend to come in short spurts. When you cap any single year’s return, you give up the potential growth from the best years. You also tend to give up the dividends on your investments (1%-2% per year). Then, you add in high expense ratios. The end result is costly.
Before you buy a buffered ETF or index annuity, remember that there is no free lunch. You’re giving up a lot of returns to cushion the downside. A better option might be to include some high-quality bonds in your portfolio. They’re still paying around 4.5% today. That’s a good baseline return to go with the portion of your money chasing higher returns in stocks.
About the Author: John O’Connor
John has more than ten years experience as an Investment Advisor. He focuses on devising and maintaining portfolios that meet individuals’ needs, investment research, and investment strategy. John has been recognized as a “FIVE STAR wealth manager” by Twin Cities Business Magazine 2016-2024. He is a CFA charterholder and CERTIFIED FINANCIAL PLANNER™ Professional.
Legal Disclaimer: These posts do not constitute an offer or recommendation to buy or sell any securities or instruments or to participate in any particular investment or trading strategy. They are for informational purposes only. CTW gathers its data from sources it considers reliable. However, CTW makes no express or implied warranties regarding the accuracy of this information or any opinions expressed by the author and may update or change them without prior notification.