Time to pause, reassess risk and possibly reallocate


I suggest the following Mark Twain quote is appropriate for this relatively long and arguably very important column: “I did not have time to write a short letter. Therefore, I wrote a long one instead.”

My apology for the length of this dispatch, but what I have to say is so important that I had to consume more real estate than I or the fine people at the Recorder would have liked. Okay, enough of the chit chat; away we go.

It is hard to believe how quickly the stock market had declined during February and March (3,000 points or about 11 percent). As of this writing, we have recouped much of the significant drop in almost just as short of time! Now that is volatility! Please keep in mind that without volatility, we would have no reason to expect higher long-term gains. One thing about market corrections is eventually they will stop. The problem, of course, is figuring out when. As we know, nobody can predict whether the recent advance of the stock market signals the end to the correction or perhaps we may test the lows again.  

The past few months remind me of what happened in January 2016, when the stock market got off to a terrible start, the worst in years. The pouting pundits of pessimism were talking recession and bear market, only to experience a head-snapping rebound. Then, during the Brexit vote, the stock market fell 5 percent in just two days (sound familiar?), which was seen as another indicator of recession.

But, it turned out to be a great buying opportunity, akin to every sell-off since March 2009. Yet, fear is a very powerful force that can drive people into very irrational behavior. My position remains the same: Just stay the course. In other words, don’t do something; just stand there! I get it; it’s easier said than done. Nonetheless, I know that in times like these, it is so easy for folks to lose faith in the stock market because we have scorched fingers and badly bruised confidence, especially from the 2008 stock market debacle. Therefore, I often remind clients and myself that my goal and No. 1 responsibility is not to make clients a lot of money, but instead, to reasonably control one’s risk in a well-balanced, efficiently diversified and tax-smart portfolio that is prudent and cost effective.

With this methodology in mind, I want to share with you a risk-averse strategy that has been around since the mid-90s but has exploded in popularity since the 2008 stock crash and the subsequent gut wrenching stock and bond market declines. During the past decade or so, investors have discovered a unique and appealing strategy for a portion of their investment portfolio. It is called a fixed-index annuity, or an "FIA.” So, what is a fixed index annuity? It is considered fixed because your account is guaranteed never to go down no matter what happens to the stock or bond markets.

Additionally, with an FIA, you essentially have two options. The first is a guaranteed one-year fixed rate. The other option is to have your yearly interest determined by the return of the stock market, measured by the S&P 500 (dividends not included) up to a “cap rate.” It only makes sense that since an FIA offers us no downside risk, we will not participate in the full upside of the S&P 500 given the cap rate. For example, if we select the S&P 500 option with a cap rate of 6 percent and the market increases 8 percent during the next 12 months, we will earn 6 percent interest or the cap rate, not 8 percent. However, if the market would decline say 5 percent during the same time period, we will not share in the loss. Thus, our interest for that period is zero.

While FIAs offer several distinct advantages over stocks and bonds, they are not without their disadvantages. First and foremost is duration. Although an FIA does allow for partial withdrawals (10 percent a year), it is not as liquid or accessible in the early years, as perhaps the rest of your portfolio. Given the benefits that an FIA offers, the sponsoring company, in order to make a reasonable profit, needs to have our money for a realistic amount of time. Nevertheless, I argue that why would one want to liquidate an FIA, mainly since it offers reasonable potential growth opportunity with no downside risk?

Moreover, since I suggest that an FIA should comprise only a portion of one’s assets, one should have other options if a need presents itself to access money earlier than expected. So what are the fees for a FIA?  Zero! Yes, that is correct; there are no fees unless, of course, you have an additional rider purchased, or you self-impose a surrender charge by withdrawing more than your annual 10 percent free withdrawal in the early years.

In closing, an FIA might be an excellent way to reallocate some of your money into a more secure alternative without sacrificing too much upside potential. I encourage you to speak to your financial advisor about this intriguing approach to investment management. I hope that you will take this time to pause, reassess your risk and possibly reallocate a portion of your assets to a fixed index annuity.

Fixed annuities may have a higher initial interest rate, which is guaranteed for a limited time period only. At the end of the guarantee period, the contract may renew at a lower rate. Unlike variable annuities, fixed index annuities (FIAs) are typically structured so that they are not securities registered with the SEC. Nor are the sales in FIAs regulated by the SEC or FINRA Regulation, Inc.  FIAs are long term insurance products. Guarantees are based on the claims-paying ability of the issuing insurance company. Withdrawals prior to age 59 1/2 may be subject to restriction and a penalty tax according to IRS regulations. Insurance products are offered through our affiliated nonbank insurance agencies. Wells Fargo Advisors and its affiliates do not provide legal or tax advice. Transactions requiring tax consideration should be reviewed carefully with your accountant or tax advisor.