Everything seems to be in an on-going state of commotion. The headlines are exhausting. In just the last year we have had fiscal cliff nightmares, continual debt ceiling fights, the drama of a government shutdown, lack of transparency in our national healthcare debate, major US cities going bankrupt, ongoing NSA privacy issues, lingering Benghazi unanswered questions, the IRS scandal and of course the familiar middle eastern chants of “Death to America!”
All of this creates a fog of uncertainty and tension for those desiring economic constancy. But the issues are really much more serious. Consider with me a broad range of public and private sector factors that threaten our estates. What about $17 trillion of government debt and $720 billion in on-going deficits? Social Security, Medicare and Medicaid are projected to cease to exist at current run rates. The viability of public pensions across the country are being questioned. What about the demise of Detroit, San Bernardino and Stockton? This is just the tip of the iceberg for many US municipalities.
Our national unemployment problem appears to be anemic with thousands of Americans leaving the workforce. The housing crisis lingers with nearly four million homeowners in some form of foreclosure or default. And what about the eroding factors of taxes and inflation? As to inflation, the Federal Reserve has simply printed too much money to escape its unintended consequences. I don’t mean to paint a defeatist picture, but the state of our nation is not good and the potential threat to individual estates is real.
But with all that said, we are still missing the biggest elephant in the room. The aforementioned economic climate has created a behemoth that can become a destroyer of individual wealth. That destroyer is a heighten level of market volatility and lack of predictability in the marketplace.
Market volatility needs to be our friend, not our enemy. We love it when the bulls are running, but when the bears come out, we run for cover. Is there a way to get the former without the later? A major market correction can be devastating, so repositioning assets might be prudent especially when the markets are trading at historic highs. If you lost money in the last downturn do you want a repeat? Of course not!
The key is to never take a loss. Ask yourself, “Are you benefiting from good market volatility while protecting yourself against the bad?” Asked another way, “What if every time the market went up you win, but when the market goes down you are protected?” Most say, “Impossible!” However, this reality is being achieved every day with a unique tool called a Fixed Indexed Annuity (FIA).
Conversely, consider the reality of having your principal at risk. Note the following S&P 500 index results since 2000: 2000 (9.11%), 2001 (11.98%), 2002 (22.27%), 2003 28.27%, 2004 10.82%, 2005 4.79%, 2006 15.74%, 2007 5.46%, 2008 (37.22%), 2009 27.11%, 2010 14.87%, 2011 2.07%, 2012 15.88%. The actual compounded annual return was 1.61% and even less when deducting a typical 1% management fee. That’s depressing!
But, what if you could eliminate the four above noted down years and make zero your friend, meaning turn the negative years into a year of zero growth? By eliminating the down years and never taking a loss, the actual compounded annual return would rise to 9.23%. Since no institution offers such an eyebrow raising strategy, consider an additional twist.
What if one could eliminate all downside risk and then lower the maximum gain in any given single positive year to a certain percentage or cap? This is what a fixed indexed annuity does. If for example a maximum gain of 6% were employed, the actual compounded annual return would have been nearly 4%, which is many times higher than the historic S&P 500 after-fee return of .61%. You may think 4% is still low, but for many who lost their shorts in the downturns, a year-to-year compounded average return of 4% is a happy headline.
Remember, not all Fixed Indexed Annuities are alike. Every financial instrument has its advantages and disadvantages. There is no perfect product, however, as we come to understand the risks we face and the goals we are trying to accomplish we are better able to choose the right club from the financial golf bag. This is the essence of financial strategy work and the value of looking at the whole chessboard. Stay tuned for a deeper dive into understanding the various components of this type of strategy.