For Many Financial Advisers, Stocks Become A Hard Sell

Life On An Equities Roller Coaster

Life On An Equities Roller Coaster

This post’s title is taken directly from a Wall Street Journal cover story that left me smiling today.

Stocks hold no allure for me anymore… Since the first day I worked with annuities, I’ve been free of the roller coaster ride of stocks- the gut-wrenching drops in value, the sleepless nights, and the fear of simply not knowing what some rogue computer program run by a kid playing with some institution’s account can do to my real dollars….

All that’s gone now… And not missed for one moment!

I take real pride in helping others find the same security.  And in case you haven’t studied real, long term yields, the rates offered on our Secondary Market Annuities are quite competitive given the safety and security of the assets.

You’re hardly giving up anything in terms of yield, and yet you give up all the uncertainty, fluctuation  risk, and worry.

You may just gain years on your life in the trade!  (It’s a fact that annuity owners live longer on average- but more on that in another post)

Here’s the story of a few poor souls who haven’t yet found the security of a good baseline GUARANTEED income… the kind of income only an annuity can provide.

Financial adviser Jeffrey Smith recently watched a once-confident client scrawl his fears across a legal pad during a discussion of stock investments: “Congressional stalemate,” “unemployment,” “European crisis,” “corruption.”

The client, retiree Nicholas Zerebny, later recalled how his thoughts strayed to Edvard Munch’s “Scream” paintings. In the middle of the page, Mr. Zerebny drew a crude version of the iconic screaming face.

“That’s how I feel right now,” he told Mr. Smith.

For Mr. Smith and other U.S. financial advisers, that anguished cry—real and metaphoric—has become a familiar part of the job.

Since hitting a recession-driven low in March 2009, the Dow Jones Industrial Average has doubled in value. But many ordinary investors remain too fearful to join in the gains.

After two stock collapses in one decade—2000-2002 and 2007-2009—along with scandals, the rise of high-frequency trading and worries over Washington’s ability to rein in debt, Americans are pulling out of the market. Individual investors yanked a net $900 billion from U.S. equity funds since January 2000, according to fund flow tracker EPFR Global. Penny Stocks and stock mutual funds now make up 37.9% of the average U.S. household’s financial assets, down from 50.5% during the height of the tech-stock boom in 2000, according to the U.S. Federal Reserve.


Here’s the Source:

Annuities Allow For Higher Yields- Moshe Milevsky In The News Again


For once, the Wall Street journal has published an article that I agree with on the topic of annuities!

For years I’ve cringed as their “Buy and Hold Stocks and Bonds” tunnel vision routinely ignored or bashed annuities.

But today brings a good article that I agree with, advocating to create a guaranteed income floor  that will allow  you to take more risks elsewhere to chase higher yield (if you are so inclined).

It’s exactly the strategy I advocate with clients on this and our other websites.

Because it’s so unusual for the Journal, I’m going to quote it entirely below.  It appeared Here first.

Moshe Milevsky, one of our favorite writers on the guaranteed income landscape, features prominently as well.

For those concerned they might outlive their assets, annuities can provide a guaranteed income stream.

But for those who go this route, a big question remains: How should your annuities affect the rest of the portfolio?


In general, investing professionals say that putting part of one’s nest egg in annuities can open the door to taking on more stock-market risk, which in turn offers the possibility for more portfolio growth.

Matt Grove, a vice president at New York Life Insurance Co., who heads the company’s annuity business, says owning annuities can allow investors to increase their risk exposure in part because annuities are so different from conventional securities. For instance, there are types of annuities that provide a set monthly check for life and that are completely independent of the ups and downs of the stock market, he says. And mixing uncorrelated assets is a key strategy in managing portfolio risk, whether you are talking about annuities or simply diverse types of securities.

Brett Wollam, senior vice president at Fidelity Investments’ life-insurance unit, suggests retirees use income annuities along with Social Security and pensions to fund their essential expenses. When there are several sources of guaranteed income, retirees can invest more in products with growth potential than they might have otherwise, he says.

“Typically, investors are too conservatively invested” in retirement, Mr. Wollam says.

What’s Your Tolerance?
Fidelity Investments Life Insurance Co. sales manager Robert Cummings gives an example of a 60-year-old couple who changed a portfolio that was invested largely in cash to one with a 45% allocation to two annuities and a 28% allocation to equities. The couple weren’t knowledgeable about the stock market, but they knew longevity ran in their families and were concerned about inflation, says Mr. Cummings. “Both factors speak to the need for growth because of the time horizon they are planning for,” Mr. Cummings adds.

The couple’s annuities now include a $200,000 deferred-income annuity from New York Life with a $1,057 monthly payout starting in five years.

Of course, not all annuity purchasers should increase their exposure to stocks. To some degree, the decision depends on the investor’s risk tolerance and the types of annuities he or she owns. With variable annuities, the value of the contract can fluctuate with stock and bond prices. At the same time, fixed-payment annuities could involve risk if the issuer is on shaky ground, or if the annuity lacks automatic increases to protect against inflation.

In some cases, in fact, annuities may help an investor ratchet back too great a stock exposure.

Reduced Risk
At Steele Financial Solutions in Cherry Hill, N.J., Joel Steele recommended that a 61-year-old client with 100% of his portfolio in equities reduce his risk exposure and invest in deferred-income annuities. The client had booked some recent gains in stocks but was generally frustrated with the continuing ups and downs of the market, Mr. Steele says. Even with the recent gains, he adds, the client’s portfolio was only back where it had been 10 years earlier. The client also was anxious that his pension wouldn’t provide enough income for his wife in the event of his death.

At Mr. Steele’s recommendation, the client invested half of his assets in two deferred-income annuities with guaranteed monthly payouts starting in two and 15 years. Of the remainder, he has 17% in stocks and the rest in income-producing bond funds.

“He’s not completely out of the [stock] game, but he’s not going to be affected by any stock-market crash either,” Mr. Steele says. “We’re not talking about taking people out of the market,” he says of balancing deferred-income annuities and equities. “We’re just making sure they’re OK.”

Moshe Milevsky, an associate professor of finance in the Schulich School of Business at York University in Toronto, says that for income protection in later life, the best annuities are those that delay payments at least until the purchaser reaches his or her 80s. The payouts for these types of annuities tend to be bigger than for annuities whose payments start earlier, but many potential investors see the long wait as too much of a gamble.

Indeed, these products, generally referred to as advanced-life delayed annuities, or longevity insurance, have proved a hard sell for the insurance companies that offer them (see sidebar). But according to Mr. Milevsky, delayed payouts enable purchasers to allocate more of their portfolios to investments with higher growth potential, compared with purchasers of annuities that start their payouts within a few years.

Mr. Milevsky is also founder of QWeMA Group Inc., a developer of products for wealth management, investing and insurance, with a focus on retirement income planning. Based on algorithms that he has developed, the company, whose name is an acronym for Quantitative Wealth Management Analytics, recommends mixing longevity insurance and mutual funds as a strategy for protecting income in later life.

The Riskiness Of Stocks- A Zvi Bodi Article

S+P Roller Coaster

S+P Roller Coaster

I read a recent series of questions and answers in reply to a timeless cover story in the Wall Street Journal on the riskiness of stocks.  The article, by Zvi Bodi, covers the essential teachings of Professor Paul Samuelson, who wrote extensively on risk.

The essence is this: flipping a coin has a 50% probability of heads with each toss.  Tossing  for years does not change your odds.  Likewise, stocks are risky at ANY given time- MANY given times has no effect on the risk at A given time.  In other words, your risk is high no matter what.

So while time does not mitigate your risk, other factors may, such as your human capital or earnings potential. However, the reverse is also true.  As you get older and your earnings power diminishes, or your number of remaining earning years declines, your risk tolerance should also decline.

There are many fundamental reasons for guaranteed income such as annuities, but the wisdom from these economists is perhaps the most compelling.  With every day in the markets you roll the dice.  How lucky do you feel today?

I’ll quote a personal highlight:

A safer way to build and protect retirement assets is to picture your goals as clearly as possible. Then pare things back to the basics. Figure out the bare-bones level of income you need and invest in products that guarantee it……. Use the rest of your investment money to build reserves to fund your aspirational goals.

This describes perfectly our approach to annuities and financial planning- identify your baseline needs first, and cover those guaranteed expenses with guaranteed income.  Then, optimize the rest.. as you see fit.

Below you will find the rest of the article.  My only complaint is that like it does not mention annuities anywhere, when they should be foremost in the discussions of low risk alternatives to the markets.  Especially our Secondary Market Annuities- for all the complicated strategy described below of laddered TIPS and zero-cost collars and such, the simple truth is that a 5 to 6% guaranteed effective rate of return over many years is a GREAT rate of return.  No matter who you ask, no matter what market periods you look at….

With the long term guaranteed yields we have available to you in mind, enjoy the rest of the article below.

Why Stocks Are Riskier Than You Think
Most people can get the money they need for retirement without gambling heavily on equities, say Zvi Bodie and Rachelle Taqqu

A growing sense of urgency is driving many investors to take reckless risks with their money.

Even though they experienced the hazards of stock ownership firsthand in 2008, investors are venturing back into equities again. They’ve been advised that there’s no other way to make up the losses they suffered—or meet their looming retirement requirements—and, not to worry, the risk of stocks diminishes the longer you hold them. The Federal Reserve, meanwhile, has announced that it intends to keep interest rates low through 2014—providing a powerful inducement to stay in stocks since bonds will probably generate unusually low returns.

The desire to get back what you lost is understandable. But, as behavioral economists have shown, it can also cloud your judgment and lead you to take more risk than you can handle.

Despite the assurances of the financial industry, stocks are always a risky investment, and the longer you hold them, the better your chances of getting blindsided by a downturn. The usual way of mitigating that risk, diversification, holds no guarantees, either—for the simple reason that investments don’t always move the way we want in relation to one another.

A safer way to build and protect retirement assets is to picture your goals as clearly as possible. Then pare things back to the basics. Figure out the bare-bones level of income you need and invest in products that guarantee it, such as inflation-protected bonds. Use the rest of your investment money to build reserves to fund your aspirational goals.

But when you’re aiming to meet your aspirational goals, there is a way to limit your downside risk—by using instruments that let you limit your losses at the cost of some upside potential. You can do this through direct purchases of options, or you can buy mutual funds that use complex hedging strategies. These funds aren’t as transparent as stocks, but their aim is to protect your money from disaster.

A Hard Look at Stocks
It may be hard to let go of the belief that buying and holding stocks is a sure-fire key to asset growth. But that’s because people have been lulled into thinking that long-term stock investing greatly reduces the risks. The truth is that stocks are risky no matter how long you hold them.

Yes, equities can be expected to produce a superior average return in comparison to safer investments. That’s as it should be, because the higher return compensates investors for taking the added risk. But this does not mean that stocks become less risky over long time horizons.

There are a number of different approaches that demonstrate why the conventional wisdom about stocks is wrong. One of them has to do with bear markets, which happen regularly; the long growth stretch that began in 1983 and lasted through the 1990s has not been the norm. And the longer you hold onto your stocks, the greater your chances of running into one of those downturns.

Even with the long boom, bonds outperformed stocks over the 30 years since the fall of 1981—delivering an average annual return of 11.5% vs. 10.8%, respectively—with less risk and less volatility than equities.

To prove their claim that stocks are not very risky in the long run, stock enthusiasts argue that stocks have beaten bonds for every 30-year period starting in 1861—except for the most recent one. But their evidence is much thinner than it appears: Since 1861, there have been only five non-overlapping 30-year periods! Statistically, that’s simply too few independent periods to justify the conventional conclusions.

What’s more, the idea that “stocks do well in the long run” isn’t a practical guideline for individuals. For one thing, the “long run” means something different to different people depending on their ages and goals—for some, it’s 10 years, for others 30. And while the odds of getting good stock performance over that time are good, the consequences of a downturn can be severe, depending on how steeply markets decline, how much you have in the market, and when the downturn hits in your lifetime.

If you’re expecting stocks to outperform, say, 70% of the time, you need to think about how much you stand to lose the other 30% of the time. It does not do you a lot of good to have 20 years of great performance, only to be trounced in a crash just before you retire.

The usual way of protecting a portfolio—through diversification—is sensible and advisable. But it’s hardly a guarantee. Diversification aims to provide stability by mixing up different classes of assets, which are expected to behave differently in different circumstances.

Yet the correlations it’s based on aren’t constant. Bonds and stocks have moved in opposite directions at times, but in other periods they have not. And foreign markets are growing less and less decoupled from the U.S. Recently, prices of assets as diverse as large-cap domestic stocks, emerging-market stocks, oil and gold have been fluctuating together rather than in counterpoint.

A Safer Strategy
What’s a better approach to building a portfolio? First, forget the idea of “catching up.” Most of us find loss so painful that we’re willing to go out on a limb just to recover what’s gone. We’re willing to take risks we’d normally avoid to recoup what we see as rightfully our own.

Instead, when you start by looking at your destination and focus on what you absolutely need, you protect yourself from missing your essentials if the market falls short. And you steel yourself against a blind obsession with recouping loss.

Separate your basic must-have needs from your aspirations or wants, and create an investment plan that guarantees the basics with inflation-protected, safe investments. You may be surprised at how much less you need than you want, but try hard to be honest with yourself. Then put any other investment dollars you have available each year into riskier vehicles to meet your aspirational goals.

Intuitive and straightforward as this approach may seem, it’s not commonly pursued by most investors and advisers. Assessing what’s really necessary takes time and reflection. Few people do it systematically, if at all.

Once you decide how much money you need for your basics, create a safety net to guarantee that you can cover them. That’s where securities that protect against inflation—such as TIPS and I bonds—come in. (Although many people include insured bank certificates of deposit in this mix, CDs don’t provide inflation protection.)

For the best safety net, put together a “ladder” of TIPS, held in tax-deferred or tax-exempt accounts. Figure out how much money you need each year, then invest in TIPS with maturities that match your future spending dates. Your plan won’t be perfect, of course: Your personal rate of inflation may not match the Consumer Price Index, taxes may intervene, and life happens. But don’t let the perfect be the enemy of the safest available choice.

Today’s low-interest-rate environment poses some difficult challenges even with a bare-bones safety net in place. Today, TIPS and I Bonds do not yield more than the rate of inflation. And many people are starting practically from scratch, whether because the market collapse set them back enormously, or because they have not managed saving much for retirement yet.

It’s impossible to generalize about every investor’s situation, but many households are probably facing the prospect of a very small safety net in retirement.

With that outcome in store, many people may be tempted to gamble on riskier investments to meet their retirement needs. But your safety net is meant to be the money you can count on. By definition, you don’t want to put it at risk. If you bet your basics in the market and lose, you can easily end up worse off, with less to spend on your essentials.

If you don’t think you can create a safety net that’s big enough, there are other steps you can consider, although they can be tough. You might spend less today to save more for tomorrow. You might work extra jobs, move to a higher-paying career or retire later. You can also try scaling back your definition of needs.

How low can you imagine turning down the jets if need be? Is a community college a viable alternative for your child’s first two years out of high school? Can you lower your expenses in retirement by moving to a less-expensive location, downsizing your residence or traveling less?

It’s this kind of assessment that should be driving your risk decisions. It requires careful and honest introspection, as well as a lot of consulting with the key partners in your life.

Limiting Your Risk
Now that you’ve separated your needs from your wants, you can decide how much to limit the risk you take with your aspirational investments. If you’ve lived through 2008, you probably don’t want to see losses of 30% to 40% ever again.

There are several ways to protect the money outside your safety net. For instance, there are investment products that protect either principal or income by using hedging strategies involving various combinations of derivatives.

But you must be careful to read the fine print. You need to understand the managers’ strategy in detail, including which risks they’re hedging and which risks remain unhedged. It’s also important to weigh a fund’s expenses, both embedded and explicit. The costs of these transactions can be high, so do look carefully at the expense ratios of the fund along with all its fees.

Investors who are more seasoned can undertake some of these complex strategies on their own. For instance, when you buy an investment such as the S&P 500, you can buy a put option on it, too. This gives you the right (but not the obligation) to sell the investment at a future date at a price you determine at the time of purchase. Since your investment can’t fall further than the “strike price” you’ve selected, you’re effectively setting a floor on your losses.

Let’s say you buy SPY, an ETF that tracks Standard & Poor’s 500-stock index, at its recent price of $136.41. You’re willing to sustain a 15% loss, but not more, so you buy a put with a strike price of $116. Since you can now sell SPY at $116, you’re protected in case it drops any lower. Essentially, you have bought insurance with a deductible of 15%; that’s all you can lose.

Is it worth it? The put in this example, which expires in four months, would have cost $2.16 at the time you priced and bought your ETF shares. But the good news is that there is a way to avoid the cost of the put, by trading away some of the upside of your SPY shares. You can sell a call on your investment. This means that you are selling someone else the right to buy it at a stated strike price on or before a future date. If the shares reach the strike price, you are obligated to sell.

In order to end up with a near-zero cost for your options, the prices of the put and the call will have to be roughly the same. In our example, there is a four-month call that is priced at $2.17—close to the $2.16 you paid for your put—and it has a strike price of $143.

When you sell this call, your proceeds fully offset the cost of your put. If the value of the ETF rises before the option expires, you get to keep everything up to $143. But not more than that: Your gains beyond $143 have been traded away. So the strike price of the call you sell is the upper bound on your potential gain.

In this strategy, called a zero-cost collar, your costs are limited to your transaction costs alone, since your proceeds from selling the calls will zero out the cost of the puts. And your investment outcomes are now limited as well: In this case, you can’t lose more than 15% on the downside or gain more than 6% on the upside.

If you want to increase your potential upside and still have the costs cancel out, you’ll need to lower your floor. In our example, you can increase your potential gains to $147 if you are willing to take losses all the way to a lower threshold of $108 (that’s a loss of just over 20%). It’s akin to increasing your deductible on insurance in exchange for a reduction in the premium you pay.

For the most part, “structured” products for limiting risk are still on the drawing table. They remain to be perfected. But the notion of sacrificing a limited amount of safety in exchange for upside potential is profoundly relevant to retail investors’ needs right now.

So keep your eye out for them: It should not be long before growing consumer demand transforms them from next-generation investments into products whose time has come.