The “Immutable Law of Investing” is: “Risk and reward are traveling companions”. Investments promising to double your money rapidly can also erase your money quickly. The promise of a 12% return in today’s market also has a high probability of loss. The only exceptions are investments with guarantees – a very short list. Yet, investors constantly search for exceptions to this “Immutable Law of Investing”.

There are numerous “kinds of risk” that investors face. The most common faced by the typical investor are: (a) interest rate risk and (b) market risk. Of course there is also the risk of insolvency (corporate bonds), liquidity (real estate), currency exchange (off-shore investments), sovereignty (bonds of foreign governments), inflation (purchasing power), legislation (tax law changes) and numerous others. But, let’s limit this discussion to the most common: interest rate and market.

Market risk is perhaps the best understood and most commonly associated with stocks or other investments that can vary in price. Regardless of the “professional recommendation” or past performance, there is no “absolute safety” when purchasing investments whose price can fluctuate. American business icons have failed and investments in them made worthless because of fraud, mismanagement, terrorism, class action lawsuits, product liability, government investigations, rapid technological changes, weather, and countless other causes not foreseen by “experts” or anticipated by stockholders. Granted, “blue chip” stocks are not as risky as “penny stock”, but there have been spectacular, and unanticipated, failures of “blue chip” companies. If an investment can wax and wane in value, then it has market risk and the saying “caveat emptor” (buyer beware) is appropriate. Your clients’ retirement nest eggs in stocks, bonds, mutual funds, variable annuities, real estate and general securities are exposed to market risk and losses can, and may, occur. Only if they can “afford the risk” should they “assume the risk” because there is a safer alternative.

Interest rate risk is encountered daily but understood by few. This risk exposes even gilt-edged securities like U. S. Government Bonds to massive losses. For example, a 30-year Treasury bond paying 5% interest is purchased today at par (face value at maturity). Interest of 5% will be paid every year and at the maturity in 30 years the principal amount will be repaid. But, what happens if interest rates on similar bonds rise to 10%? Every interest payment on the 5% bond is below market because now it would take only one-half the investment to earn the same amount of money. Or, put another way, if you sold the 5% bond, a buyer would offer you only one-half what you paid for it. Regardless if you hold or sell, you have lost opportunity or a loss. The cautious, but uninformed, investor may (a) buy only short term bonds (or bank CDs) with low interest rates, (b) buy only when interest rates are at the peak (is this possible?), or (c) avoid fixed-rate investments if selling early might be needed (medical emergency or need for liquidity). Again, there is a better alternative that offers safety.

So what’s a typical investor to do to minimize risk, maximize safety and preserve a chance of getting a market return? How about an investment that is guaranteed to only go up in value, will participate in market gains as they occur and avoid market declines if they happen, will avoid current income taxes on earnings, has no brokerage fees or other charges, has liquidity for emergencies, and is guaranteed by a global company with decades of operational stability and integrity? I’m speaking, of course, about equity-linked fixed annuities. There’s no market or interest rate risk, and they’re guaranteed by some of the largest, oldest and financially strongest insurance companies in the world that have survived wars, changes in governments, depressions, technological advances and virtually every shock that could occur. Granted these annuities are not for those that want to take risk, enjoy the thrill of seeing their investments go up and down like a yo-yo, and are willing to lose it all in hopes of doubling their money overnight. Equity-linked fixed annuities were designed for long-term savers that are building, or guarding, nest eggs for retirement and do not want, and cannot afford, to risk a diminished lifestyle after decades of working. The exception to the “Immutable Law of Investing” is: Equity-Linked Fixed Annuities, commonly known as Equity Index Annuities or just EIAs. I told you it was a very short list!

Does ‘buy and hold’ work when the market goes up and down like a yo-yo?
How do you feel about your investments? Everyone we talk to is a bit freaked out about the stock market. In the last 2 decades we have witnessed too many episodes of serious financial crisis that have wiped out retirement savings accounts virtually overnight. It has been very unsettling to think about the security of older individuals’ invested assets in such volatile market environments.

The day we began to write this, the S&P 500 index went up and down nearly 10%. To say that is volatile is an understatement.

You know what everyone says: If you are in the market for the “long-term” you don’t have to worry about the short-term volatility or losses.

We suppose that made sense in earlier times and when you may have been in your 20′s, 30′s and even 40′s. But what about now and what about if you are in your 50′s, 60′s and beyond?

This is a new very volatile world and we wrote this to give you something to think about and determine if buying and holding stocks or mutual funds right now is a good idea even when looking at the long term.

Ask yourself this question: If the stock market goes up and down and up and down over a ten-year period and ends up at the same point ten years from now, will the account balance be the same at the end of the ten-year period?

If you invested $100,000 in the S&P 500 index which started at say 1,000 points and if the index went up and down like a yo-yo for ten years and ended with a value of 1,000, would your initial investment still be $100,000?

The answer is absolutely NOT! Look at the following chart where we assumed a very volatile market that goes up and down 10% every other year and after ten-years the average return is ZERO. You’ll notice that the account value is $95,438. And guess what, we haven’t even accounted for inflation!

Never go backwards and lock in gains. Many of you know that Fixed Indexed Annuities (FIAs) can be used to hedge the risk in the market and to earn decent returns when the stock market does well. FIAs are not a cure all. Not every penny of someone’s money should be in them, but as an asset allocation model, the older you get, the more money you should have in a wealth building tool that will not go backwards. 

What if the $100,000 invested in the above example instead went into FIAs?  If we make a very conservative assumption that over time the cap on returns will be 8% annually, look at the results. 

Why did the FIA end up with an account balance of $146,933 instead of $95,099? Simply put, in down years, the FIA returned zero instead of -10 percent, and in up years it returned 8 percent.

Are these real-world examples? Who knows, they could be. The question of the day is: Are you doing everything you can to protect your money in this uncertain world?

It’s one thing to be upset when you only earned 8 percent when the market is up 10 percent or more; it’s another and much more positive feeling when your money earns zero when the market is down 10 percent. The first feeling you experience could make you a little grumpy, but the feeling that will immediately follow — even though it sounds odd to be happy with a zero rate of return — brings a nice smile to your face (especially if you are over the age of 60-65 and close to or in retirement).

Just in case you’re curious, if the market has a wild swing of 20 percent every other year (up and down), the account balance at the end of 10 years in the S&P index would be $81,537, and the FIA account balance would remain at $146,933.

Conclusions

I’m not sure if the days of “buy and hold” as a tried-and-true way of growing your wealth have come and gone. That may or may not be the case. What I do know is that it’s time to have a discussion with a financial professional to understand all the various options available to grow and protect your wealth, and I think that conversation should include the information discussed in this article.