While many resolved that 2016 would be a year of success, the markets seemed to have a mind of their own. In early January, investors helplessly watched the stock market put in its worst opening week ever. Specifically, the Dow, S&P500 and NASDAQ all had their worst opening five days in history.
Despite the fact that these new horrible records were created, a negative start in the markets doesn’t always indicate that this year is already destined to be a write-off. In fact, there have been years when the markets have gotten off to a rough start and have ended with strong, positive returns.
One cannot help but listen to the news and hear terms used by market speculators that we might be headed for a bear market vs the long bull market run we have had since 2008. But speculation is just that. It is speculation. No one has a crystal ball forecasting if an impending bear market is upon us.
An easy way to remember the difference between a bear market vs a bull market is with this simple metaphor. Picture a bear fighting. What does it do when it attacks? It stands up as tall as it can, claws raised in the air and with all of its body weight, it “falls” upon its prey. Counter to a bear market is a bull market. When a bull gets ready to engage its opponent, it will lower its head and thrust its head and horns up as sharply as it can. So the next time you hear bear vs bull market, think of their different fighting methods to help you decipher the lingo of what the media is talking about. A bear market is when stocks decline at least 20% from their peaks. Yet a market correction can be defined when stocks fall 10%. We have already experienced this –10% loss since this article was written.
A bull market, on the other hand, is when stocks rise approximately 20%. It is possible to have multiple corrections within a market cycle and still be in a bull market. Typically, there is about one market correction per year.
As investors, we are taught to “buy low and sell high,” but human emotion can override the brain as we watch our money dwindle away out of our control. Taking the emotion out of investing is nearly impossible for even the most stalwart and seasoned investor. A volatile market influences too many to sell low to get away from the risk.
Those with the greatest cause for concern in an uncertain market are pre-retirees thinking they want to retire soon. For these pre-retirees, watching the markets fall can be like playing musical chairs at a birthday party when they were children. The music played and everyone danced around the chairs smiling and laughing, but when the music stopped almost instantaneous panic set in to find a chair to be safe. Investing is not really much more than that. How much time left in the workforce do you have? The number of pre-retirees who had their retirement dreams delayed or shattered in 2008 because they lost close to 40% of their retirement portfolio must have been staggering.
Those who are young enough, and have time on their side, can afford to experience the emotional highs and lows of being invested in the market. For those who don’t have the time (or have a weaker heart), perhaps now is a time to analyze if being in the market really is the best thing for you.
Understanding where you stand financially and the implications of loss in the market is important for any investor. The average investor should break down their investments into two categories. The first is money at risk. Risk is not bad by any means. Each day we get out of bed has an element of risk. Proper risk management is determining what level of risk we are willing to accept.
For those who are ok with some level of risk, the stock market is the most common place for an investor trying to grow their investment nest egg. Any investor who participates in the stock market needs to accept that there will be market volatility and be ok with that volatility. If you cannot afford to lose, you shouldn’t be in the stock market. Having the wrong stock positions in your investments can get your head chopped off in a hurry and derail a successful retirement plan.
Investors who simply are not comfortable risking all or any of their retirement money in the market typically purchase insurance contracts or annuities. These financial vehicles are designed to take the risk out of the investment. Annuities in the past have gotten a black eye, and they deserved it! But the annuity industry has wised up and given the client much more control of their funds. In years past, a person would have to annuitize and surrender all control of those funds forever. Gone are those days. Annuity companies rarely if ever annuitize anymore and allow for better client control.
The most stable vehicle right now is known as a Fixed Indexed Annuity. The product in a nutshell is a glorified CD that you would get from your bank, except the returns are often much better.
Just why do investors run to their bank when the market declines? Because it’s safe from loss. You can never lose your principal, but in reality you still are losing because inflation is much higher than what you are earning at the bank. Inflation is eroding your future purchasing power.
Think about all the money just sitting in the bank doing nothing. As a result of that sobering fact, many annuity companies offer a bonus on any money going into the policy. Usually the bonuses range from 4 to 7%. If an investor has $100,000 to put into a Fixed Indexed Annuity contract, the company will give them an instant $4000-7000 bonus depending on the company and the state it was signed in.
A Fixed Indexed Annuity guarantees that you will not lose any principal, ever, just like the bank. The annuity is often tied to an index like the S&P500. Whatever the index does, the investor typically gets all of the upside potential minus a small spread. Think of it like a haircut. It comes right off the top. Let’s say the market goes up 7% and the spread is 1.5%, the owner of the Fixed Indexed Annuity will net 5.5% that year with no market risk.
Be aware that in order to keep your funds “safe,” there typically are tradeoffs when buying an insurance or annuity product. The tradeoffs are the lack of large gains that can be associated with the stock market in some years. When you agree to let the insurance company remove all the market risk, you are often agreeing to reduce some of the upside potential growth. Annuities and insurance can make good gains, but they typically are conservative gains. However, if you aren’t losing and only growing, then conservative and stable just might be the name of the game for you.
One of the favorite reasons to go with this product is that the financial advisor is paid out of the insurance companies’ pockets instead of the investor’s. Say the same investor from above puts their $100,000 into a Fixed Indexed Annuity. The next day it’s still worth $100,000 plus the initial bonus because no commissions were paid out of the investor’s principal. The insurance company pays the advisor out of the insurance companies’ pockets.
One should understand that Fixed Indexed Annuities have a realistic rate of return between 3 to 5%–still much higher than what a bank offers. Sure there will be years you will have better returns than that, but historically 3 to 5% is a good number that you can count on. You win by not losing.