Redefining Income Planning

It seems much longer than 8 years ago when income riders within Fixed Indexed Annuities (FIAs) provided guarantees never offered.  Historical income value roll up rates that were as high as 8% are now being outperformed by uncapped strategies.  To me, its amazing to see how the evolution of income planning has redefined itself, especially in under a decade.  Today, more financial professionals are redirecting retirement funds into FIAs that provide increasing income streams, as well as uncapped strategies, for life.   Depending on when you plan to retire will determine which increasing income strategy may be best equipped to meet your needs.  This is why it is important to work with a professional who specialization lies within income planning solutions.

The days of FIA annual point to point strategies that can only provide a return of 3.0% are well behind us, and good riddance.  Through many of today's specialized indexed strategies, policy owners within a FIA can now participate in 90% + of the market upside (within a predetermined indexed strategy) with absolutely zero downside.  This means that you can never lose your principle or earned interest moving forward, regardless of how the market performs.  As this past recession has shown, principle protection in down markets is key to making your retirement a reality.  These recent uncapped strategies are causing more financial professionals to redirect client funds into guarantees absent in a turbulent market.  Depending on what your individual circumstances (retirement time-line) are will depend on which strategy may best suit your needs.

Income payouts within FIAs can illustrate much higher than ever before.  Income Account Values (non cash values) used to determine income payouts can participate up to 250% of a selected index return while in deferral.   Additionally, annual income payouts can increase by up to 150% of the same selected index.  For example, one particular FIA that has a 6% annual return (of a selected index) would result in an income payout increase of 9%, never to decrease!   Furthermore, each year the selected index increases in value the income will continue to increase by 150% respectively. Within a couple of these strategies I have seen income payouts potentially double within a 15 year period, while continuing to increase for life!  These are income payouts that have never been seen before, specifically designed to protect retirees from absent pensions and a bankrupted social security system.

So how did this evolution happen?  Simple.  Over the last several years analysts have learned to maximize the upside potential within specified indexes, while protecting the profitability of the issuing company.   Because of the extreme market fluctuations we have seen since 2008 (the most volatility since the Great Depression) statisticians and actuaries have been able to capitalize on market profit points, passing on the gains to the policy owner.

Where the evolution of income planning ends up remains to be seen.   I can tell you from personal experience that today's potential income payouts and uncapped strategies were never contemplated 8 years ago.  FIAs today are replacing fears of inflation and market downturns with comfort and predictability.  Now, finally, retirement can be planned with a higher quality of life than ever before!

How To Pick The Right Indexed Annuity

When it comes to lifetime income there are many options to consider within a fixed indexed annuity (FIA). Preferences may vary from hoping for upside market performance, to a more conservative approach with a fixed rate of return. It is important to assess each option to make sure you are picking the right FIA to meet your long term needs. Which way you decide to go can drastically effect the amount of income you can receive moving forward.

One FIA providing lifetime income will credit interest based on market performance. The better the market does, the better your income payout is down the road. In fact, there a few of these indexed annuities that provide increasing income in market up years that will not lose income down years. Typically, these kinds of annuities usually payout based on performances of a market index, like a spread on the Barclays Bond Index or a capped version of a like index. Choosing how your funds are allocated will determine what your future income looks like. Therefore, how your funds are allocated will dictate how much of a cap, or upside, you will make in a given year. The downside is that if the market performs poorly over a given time period, your starting income may be lower than anticipated. To help put it into perspective, insurance companies can provide detailed illustrations to show income performance based on the last 10, 20, and 30 year look backs. What this means is they show a period of time in the past as an example of how your annuity income may pay out moving forward. If you choose this type of payout for your annuity income within retirement, it is highly recommended that you use a diverse option with respect to allocation percentages to help balance unforeseen market events; which in turn can protect your payouts in the future.

The argument when choosing the best market based performance income annuity is in how to determine market performance moving forward. Factors such as domestic and global federal stimulus packages have deviated the market from its norm. It is evident that what caused market fluctuations over the last few years is completely different than what we have seen in the past 10, 20, or 30 years. So from a certain perspective, what we see moving forward may work in opposition to what we have seen in the past; especially given the state of our global economy.

Another option when considering lifetime income is the fixed option with the income account value (IAV). The IAV is a feature on some indexed annuities that is separate from the cash value, strictly used for income calculation purposes. Therefore your cash value and your IAV value will be of different values (the IAV value will likely be higher as time goes on) throughout the lifetime of your annuity. The IAV receives a predetermined rate of return each and every year until you start the income, guaranteeing a payout regardless of market performance. The risk being that extra income may be left on the table in the event of a strong market performance. Today, this rate of return will usually average 6 – 8% annually with a predetermined payout dependent upon age. The older you are, the higher the payout. Because this is more of a conservative approach, the insurance company may allow provisions within the IAV to allow increased income in the future when poor health follows in retirement. The purpose is to provide the retiree with additional income for external costs associated with long term care or the need of nursing assistance. Once again, this type of FIA is generally for the more cautious retiree who wishes to leave nothing at chance with his/her lifetime income. With this strategy the retiree can purchase this annuity and know exactly what income they will qualify for up to 10 plus years in the future.

One of the main dilemmas on choosing the right IAV within your FIA is both the income and interest crediting options your contract will come with. I always use the analogy: what you don't make on the popcorn you make on the peanuts; meaning you may sacrifice a lower rate of return on your cash value in exchange for a higher lifetime income payout within the IAV. Typically higher lifetime income payouts within the IAV come with lower caps on the cash value which can restrict the amount of interest you can earn. Remember, pretty much all FIAs today give the option of partial withdrawals to lifetime income (within the surrender period) as a liquidity feature. This gives the retiree the flexibility to stop and start his/her lifetime income at their discretion and instead take a partial withdrawal. The partial withdrawals are contingent upon the cash value, not the IAV, so how much interest you earn on the cash value can be detrimental to how much you can withdrawal over retirement (assuming the lifetime income is not elected). Furthermore, the cash value is usually passed on to the beneficiary in the event of death, not the IAV. This is why it is important to find a professional that can show you a perfect balance between your earned interest on your cash value and your IAV payout.

When choosing the right FIA for your income needs it is crucial to determine what your risk level is. The more aggressive, optimistic approach generally follows the direction of the lifetime income that can increase over time and is solely dependent upon market fluctuations. Whereas the more conservative approach will tend to lean towards the fixed rate of return with the IAV while adding long term protection, providing a guaranteed payout regardless of market performance. Whichever way you go on your lifetime income, it's crucial to know the facts to make the right decisions for retirement income.  

Permanent Life Insurance: The financial perks

Who would have ever thought that one of the most attractive tax deferred, cash accumulating vehicles could be found inside a permanent life insurance contract?  Imagine that, insurance policies that have outperformed the S & P 500 over the last 15 years with respect to cash accumulation.  If you haven’t heard this concept, I strongly suggest that you educate yourself on all of the benefits that you have been missing out on.

One of the ways to accumulate cash within a permanent life insurance company is through an indexed universal life policy.  These products allow for capped gains in the market while expelling any possibility of losing a penny to market volatility.  This is possible through a concept known as annual reset.   Annual reset allows you to earn a portion of the market upside, while bypassing the market downside; usually over the span of a calendar year.  Added to which, with this concept it is not possible to lose a penny of your money when the stock market takes a hit.  This is a philosophy that many investors and businesses are openly embracing, especially with tax advantaged withdrawals.

Since indexed universal life (IUL) is a form of permanent life insurance, it is subject to an accounting measure known as FIFO.  FIFO is an acronym in accounting known as first in, first out.  This means that all of the principle that is deposited into an IUL policy is able to be withdrawn before you are required to pay ordinary income tax on the interest earned.  In other words, interest is only paid when all of the principle is withdrawn.  This is one of the only financial vehicles that will allow for funds to be withdrawn without having to pay the tax upfront.  Most all other cash accumulation vehicles require that taxes on your interest must be paid first upon withdrawal, usually as ordinary income tax or capital gains tax (assuming you’re lucky enough to have any return).   Let’s take a look at an example.   John has an indexed universal life policy worth $225,000, of which $40,000 consists of earned interest.  Assuming that John makes his first withdrawal on his policy in the amount of $50,000, he will not have to pay any taxes on this withdrawal.  Since the interest on the policy’s cash value is $40,000, all of the principle ($185,000) will have to be withdrawn before any taxes are due on the interest.  These unique features are attracting businesses by providing tax breaks they are currently not receiving. 

Businesses are using permanent life insurance as a vehicle that can accept deposits, while simultaneously withdrawing funds that do not trigger a taxable event.  This gives the business the advantage of paying invoices while utilizing tax deferral.  Another attractive benefit is that they allow business owners to have the comfort of knowing that their family’s interests are protected with an accelerated tax free death benefit.  Business owners also have the capability of protecting themselves against the unexpected passing of a key employee, while allowing that employee to accumulate funds (exempt from market volatility) for future retirement needs.   Many business owners realize that unforeseen emergencies such as the death of their top salesman, or the death of an executive, can be devastating to the bottom line both in the short term and the long term.  Costs associated with the passing of a business owner or a key employee can cause a company to collapse.  These policies protect against these concerns while allowing for tax free income (if properly structured) for their income planning needs. 

How can they do this in a depressed financial environment?  Insurance companies offering permanent life insurance products have the advantage of basing their long term goals on effective mortality tables.  Every policy owner must complete certain underwriting criteria in order to qualify for these unique benefits.  Think of it as a substitute to good credit; the analogy being, the healthier you are the better your policy should perform.  Since all policy owners are in good health and are expected to live longer (usually able to reach the mortality rates in life) the insurance company benefits from extended profits due to their policy owners averaging a longer life.    

As this financial recession lingers on, tax deferred vehicles that can allow for both tax deferral and tax advantaged withdrawals will take center stage sooner rather than later.  Policy owners who have been able to take advantage of indexed universal life products over this past decade have had the benefit of skipping over all of the down years while receiving attractive moderate return on the upside.  Do you currently have a tax deferred vehicle that can allow for tax advantaged withdrawals?  If not, what is your contingency plan against the threat of rising taxes needed to knock our federal deficit back to a manageable level?    

A Paradigm Shift of Income Planning

The retirement crisis is likely to continue given the direction our pension plans are heading.  It is no secret that the traditional pension plan is pretty much unheard of in the private sector.   Today, your only real hopes of receiving a pension are through a government job.  Even at that, state and federal governmental authorities are struggling to make the payments on a monthly basis.  This is all the more reason why employees need to take their retirement needs into their own hands. 

With the lower yields, pension plan administrators have to take on much more risk in order to keep up with the billions of dollars in monthly payment obligations.  Many payment obligations today were designed decades earlier when the economy could favor annual yields of 7 -8%.  The global recession yields today are closer to 2%.  So in order to make up difference, administrators are turning to higher risk investments, many in the form of junk bonds.  Unfortunately, higher yield potential comes with a greater chance of default.

U.S. pension plan managers are investing large amounts of capital into smaller speculative-grade borrowers, trying to yield the magic 8% yield needed for their payment obligations.  Much of this debt is from smaller start-up companies looking for capital to try and capture a small portion of a saturated market.   Borrowers with less than $500 million in annual revenue are paying much higher returns since big banks have decreased small business lending by 12% since 2008.  Big banks have decreased their lending to these smaller companies due to the default ratios they were experiencing.  None the less, fund managers are actively pursuing these debts due to the Federal government’s promise to hold interest rates low through 2014. Unfortunately, these are the risks fund managers are being forced to take on in order to make these overwhelming payment obligations.  This is a destructive trend, and regrettably a necessary evil.        

According to a study by the Pew Center on the States in Washington, states were $1.38 trillion short of their retirement obligations in 2010; which was up 9% from the year prior.  These numbers include $757 billion in underfunded pension obligations and $627 billion short in retirement health.  These numbers will continue to snowball with low interest rates making it impossible for this trend to continue without exploring alternate forms of revenue. 

A few weeks ago voters in San Diego and San Jose, California approved measures to restructure benefits for municipal workers in cities that could not afford them.  Several states including Wisconsin, Indiana, and Ohio have already started to limit collective bargaining for public employees, and have started cutting benefits accordingly.  These limitations include reduced payouts for pensions and drastically less protection of healthcare benefits.  Many other states, including Texas, are trying to renegotiate less favorable benefits for teachers and state administrators in order to help cut costs.  Eventually, government pensions are likely to go away in exchange for a deferred compensation plan, following the suit of the private job sector. 

It is no secret where this is heading.  We are seeing a paradigm shift from the responsibility of the employer to the employee.   Employees today are being forced to be more self reliant with respect to health care and retirement obligations.  Relying on employer or governmental obligations is proving to be a trend of the past.  Because of this, many employees are redirecting their deferred compensation plans to vehicles that will yield an income stream within retirement.   Vehicles not dependent upon a fund manager yielding needed returns, but instead with income guarantees backed by cash reserve pools.   These income streams are guaranteed for life and use income account values (non-cash values) to determine the amount of income one is eligible for at a given age (usually from ages 50 to 90). 

Failing to adapt to these market trends is going to result in Americans struggling throughout their retirement years because of lack of income.  Social Security and pensions simply will not exist for many in the coming years.  I believe that every US citizen under the age of 50 should not count on much, if any, social security benefits being available to them starting at the age of 62.  Furthermore, when you take into account that over 90% of workers today are not being offered pensions, the idea of a lifetime income becomes very attractive.  Once again, adaptation is the key.   Those who fail to secure their income needs for retirement can count on being a future burden to this country.         

Death of the Traditional Pension Plan

The traditional pension plan is a concept from the past that is likely to never come back to the American culture.  The concept of the pension plan is ingrained into the fabric of our country’s roots, and Generation X is going to be the first generation in US history that will not experience the benefits of this retirement plan.   Through adamant deregulation of the investment banking industry from the early 1980s throughout the 1990s, deteriorating market conditions have caused corporations to steadily abandon the traditional pension plan.     

The first pension plans in the US were given to veterans of the Revolutionary War, and more extensively in the Civil War.  The promise for a guaranteed paycheck in exchange for your services to your country was an attractive motivator for soldiers, and still is today (and rightfully so).   The concept of this idea caught wind and extended to state and local governments through the late 19^th century.  This unique retirement plan attracted several employees to governmental jobs and helped grow our government accordingly.

The first organized civilian pension plan was offered in 1920 through the Civil Service Retirement System (CSRS).  This organization provided retirement, disability, and survivor benefits for nongovernmental employees.  It was the first of its kind on US soil.  Once the CSRS was formed, the American dream of retirement became a reality for civilians.  The CSRS remained in power until 1987 when it was renamed Federal Employees Retirement System (FERS).

After the Great Depression, Wall Street integrated its entire financial planning ideology around the concept of the pension plan.  Since income planning was not an issue, thanks to the popular pension plan and social security, the accumulation of funds to supplement retirement took center stage.  This financial planning practice turned into a multibillion dollar industry for several decades.  This was able to happen because the Glass Steagall Act limited Wall Street on the amount of risk they could take on by separating financial services, which in turn allowed for consistent growth that fueled the economy and embedded the pension as the retirement dream in the US.

 The traditional pension plan started to fade quickly in the latter part of the 1980s.  Wall Street’s attempt to deregulate the financial sector, and overturn the Glass Steagall Act, was unfortunately starting to prove successful.  After the Monetary Control Act of 1980, banks were allowed to dictate what interest rates they were able to pay on CDs and fixed accounts as well as what interest rate they wanted to charge on mortgage loans.  With this act, some banks started to pay CD rates as high as 20% and charged interest rates on home loans as high as 20% as well (rates that never reached this level before).  Prior to this act, home loan interest rates were federally regulated to prevent such actions.  This ultimately led to the recession of the 1980’s and for the first time in our US history the number of companies offering traditional pension plans started to decline. 

Deregulation continued to take its toll throughout the 1990s and allowed the investment banks to control all the financial sectors without any limitations.  Once again, prior to 1980 the Glass Steagall Act prohibited these actions from taking place and in turn allowed the market to sustain positive growth for several decades.  Eventually, the actions of our top investment banks brought upon the Collateralized Debt Obligations (CDOs), which ultimately led to the Financial Collapse of 2008.  The rest is recent history. 

The steady decline of the pension plan in the 1980s was replaced with an escalating number of deferred compensation plans.  The burden of retirement was placed on the employee, as most employers could not afford to pay the pensions. Over the last 12 years most deferred compensation plans have yielded a negative return, drastically delaying retirement for many.  Volatility continues to be the norm and the only real remedy is the hopes of the Federal government cutting a check at the tax payer’s expense. 

Without refocusing long term planning efforts to income planning, this trend is likely to continue.  Most experts today agree that Americans under the age of 50 will only see a fraction of what social security pays today.  Furthermore, with the vast majority of Americans without a pension for retirement, most will be walking into retirement with near zero income.  Those who fail to act on contractual income guarantees will fall victim to this retirement trap, and their only hope is to rely on a deferred compensation plan that has at best broken even over the last decade.  Bottom line, the traditional financial planning method is not working, and will continue to deteriorate the American dream of retirement.

Today the only promise of income planning for life is offered through the Insurance industry.  Instead of focusing on hedging against risk for the investor, they focus on guaranteed payouts through a non cash value account known as an income account value.  In exchange for a lump sum amount, an investor can guarantee an income stream for life while having access to the cash value as well (a feature the traditional pension plan failed to offer).  This payment is guaranteed regardless of future market conditions through protected cash reserve pools.  The longer one waits for an income stream, typically the more income they will receive. 

During the financial collapse of 2008 the Insurance industry had record sales utilizing lifetime income.  The need for income planning could not be more important.  Investors are starting to realize that a paycheck for life is outweighing the need to try and beat the market within a global recession.  Make no mistake about it, those who fail to utilize proper income planning are likely to never retire; or at best severely delay their retirement.    

The Accumulation Phase is the Missing Link

With respect to income and retirement planning, there are 3 phases of life.  The introduction phase, the accumulation phase, and the preservation phase.  The second phase, the accumulation phase, is the phase of life where you accumulate funds to retire (working years of life), pay off as much debt as possible, and try to achieve the best quality of life you can.  This is the phase that is destroying the American dream of retirement.

Most of us grew up with the illusion that if you get an education, you’ll work for a great company and enjoy a comfortable retirement.  Those days are over.  Education (the introduction phase) still is a vital step in preparing for your career path; however, working your entire life in exchange for a pension plan is an envied dream to most Americans today, and nothing more.  Unless you are a government employee, the odds of having a guaranteed income stream throughout retirement is out the window.  This is why the planning process must be revamped when discussing the accumulation phase.  You simply are not able to work for 30 years, get a gold watch, and have a check coming in month in month out.   Today, the accumulation phase of life requires a calculated approach depending on your financial goals. 

The odds of an individual under the age of 45 receiving social security starting (earliest) at the age of 62 is highly unlikely.  With the amount of baby boomers set to retire in the next 15 years, the social security well will run dry.  When you take into consideration that most retirement strategies today are deferred compensation plans which are market linked, the scenario can become quite concerning.  Most deferred compensation plans have either broke even over the last decade, or have lost value.  So in order for one to get back on track, they are likely to have to double the historic return in a global recession; a highly unlikely probability.  So what is the solution to this dilemma?  Financial guarantees.

There are products today specifically designed to provide an income stream for life with all of the flexibility above and beyond the traditional pension plan.  Many IRAs, 401ks, and other pre tax dollar investments have been converted into specialized products that can guarantee an income stream for life.  Informed Americans are converting their deferred compensation plan into these vehicles simply because their need for an income stream during retirement greatly outweighs the burden of hedging against risk in a global recession.   The truth is most IRAs in retirement are used as an additional income stream or are passed on to loved ones as a legacy.

Let’s take a closer look at how lifetime guarantees are helping protect against the absence of both the traditional pension plan and social security.   Assume John is 50 years old and has been in the workforce (accumulation phase) for 25 years.   Since the age of 25, he has been maxing out his 401k contribution each and every year.  Three years ago John was laid off and started a new job with a lower salary soon after.  Since his current employer is not matching his 401k he sees no incentive to roll it over to that product, not to mention he cannot afford to with the reduction of income.    John has not done well on his return over the last 10 years, and was lucky to break even.  Today the balance on his old 401k is $150,000.  John does not have a pension and wants to retire at the age of 65.  His sole objective is to provide an income stream for his retirement years, as he knows he is behind in his planning and does not have a pension plan.  Furthermore, he realizes that counting on social security to be available 12 years from now (at the soonest) is pretty much hit or miss.  For these reasons, John explores a lifetime income approach.  If John were to roll over his 401k into a traditional IRA and utilize financial guarantees, he would be eligible for an income stream of over $1,650 per month starting at the age of 65 without adding one more penny to his account.  This income stream would be guaranteed for life, regardless of any future market conditions.  As an added benefit, if John were to ever become sick or have to go into assisted living, he would have instant access to all of his cash value without penalty.

There are many Americans that have very similar circumstances to John.  The number one fear in retirement today is the fear of running out of money.  Just 10 years ago the number one fear in retirement was the fear of death, as it was for several decades before.   As financial times change, so do retirement trends.  The financial crisis has caused many people to exit market strategies in exchange for an income stream guaranteed for life; especially without having a pension or being able to receive social security.

Americans for the most part do not have a contingency plan in place.  Unfortunately, there has not been enough of an emphasis on the importance of income planning.  In a global recession, priorities are placed in short term solutions aimed at the current state of the economy, failing to address long term goals.  The financial goals are concentrated to the economy as a whole, and rarely dedicated to financial guarantees in retirement.  With the Federal stimulus and the struggling economy, the individual has an inherent responsibility to plan for their future income outside the recommendations of a financial planner.  Knowledge is the key.  The more avenues you explore with respect to retirement planning the more likely you are to achieve your financial goals.      

A Realtor's Deferrred Compensation Plan

A realtor’s deferred compensation plan (DCP) cannot follow a traditional suit.  The traditional 401k, or pretax dollar, DCP is not usually an avenue pursued by realtors.  Why?  Because they don’t operate on a salary or hourly schedule, therefore funding into these types of DCPs can prove to be difficult. 

A realtor is usually a self employed professional that requires liquidity at a moment’s notice and the flexibility to fund the plan at their discretion.  This poses a problem for the traditional DCP.  For example, if a realtor participates in a DCP (like a 401k or IRA) and is under the age of 59 ½, they will incur a 10% penalty from the Federal Government for earl withdrawal, and will end up paying ordinary income taxes on all of the funds withdrawn.  Not to mention they are capped on how much they can contribute each and every year.  What a realtor needs instead is a post tax DCP that is exempt from these restrictions with all the desired flexibility. 

DCPs that we offer are funded with post tax dollars, and if properly structured can come with all kinds of bells and whistles.  First off, all of the DCP plans we offer for self employed individuals will avoid all future market volatility and will allow for moderate returns that grow tax deferred with the capability of earning interest as high as 12% year in and year out.  Some of our DCPs come with a guarantee of 2% credited in years of volatility or market downturns (regardless of how far the market falls).  Secondly, our DCPs do not have any penalties for early withdrawal, nor is there any restriction on how much can be contributed to the plan each year (payments to the plan are flexible to coincide with commission checks).  Finally, the funds can be structured to avoid any Federal income tax upon withdrawal through the form of a loan against your own funds. 

Both small business owners and professionals are actively using these types of strategies in order to protect themselves against rising federal income taxes and expected volatility.  They are applauding the fact that these vehicles do not require structured payments to fund the DCP while maintaining liquidity in order to maintain day to day operating expenses, while maintaining the capability to withdrawal the funds exempt from federal income tax.  In fact, many businesses are using this strategy similar to a checking account in order to handle monthly expenses.

To learn more about how these unique benefits can work for you, please fill out our customer contact submission form.    

Fear and Greed on Wall Street

A recent article on www.Money.Cnn.com titled “Fear and GreedIndex” illustrates an accurate description of what is happening on Wall Street.  Because of the recent volatility stemming around Greece and the Euro, and unemployment domestically, the fear gage for investors is all the way in the red.  This means that investors as a whole do not put much faith in the outcome of their investments.  Bottom line, volatility is becoming a normal event investors are unwilling to tolerate moving forward.  Why now?  It’s simple, most investors’ retirement and financial goals have been severely disrupted over the last 10 – 12 years. They have to make up the losses and know that a volatile marketplace will not get them where they need for a secure retirement.   Unfortunately, this trend is likely to continue and many portfolios will continue to suffer losses like we have seen over the last few years.   

The fear and index gage pinpoints extreme fear for investors in every category.  Every aspect of investing is being marked as red, from junk bond investing to safe money havens.  However, Wall Street’s safe money havens are quite different from other Safe Money Vehicles (non-Wall Street affiliated products).  On Wall Street, a safe money haven usually refers to either commodities such as gold and silver, which can be volatile, or FDIC insured accounts (i.e. money market accounts) that will usually earn 1/10^th of 1% interest.  Because Wall Street designs their business model around non-guaranteed leveraged assets, their safe money havens are either susceptible to loss of value (exposed to market volatility) or are accounts that basically break even (usually FDIC insured), exposing your money to inflation risk.

Make no mistake about it, the reason the fear gage is so high is because in the market, investors have no guarantees in place in order to achieve their long term goals.  With non-leveraged assets (assets with a minimum leverage ratio of 1:1) you can provide a moderate return without subjecting your money to volatility through a unique concept known as annual reset.  Annual reset is a regulated concept (financial products protected by law) that will ensure you will never take a step backwards due to excessive volatility.

There are millions of investors who have taken advantage of annual reset in order to protect their money from volatility.  Those who implemented this philosophy prior to 2008 never lost a penny in the financial crisis when Lehman Brothers fell (at that time Lehman Brothers was leveraging their assets on a ratio of 33:1), and have experienced moderate returns since that point in time.   These investors understand that regardless of how the market performs they have underlying guarantees that offer lifetime income or tax advantaged withdrawals (for those who qualify) that will avoid volatility and allow for moderate returns. 

 Never heard of these financial products?  There is likely a good reason why.  Financial planners often fail to make recommendations to products that use annual reset (offering financial guarantees) because they deem it a conflict of interest.  Financial planners are in the business of hedging against risk, not proving total protection from risk.  These philosophies differ by the way the planning phase (usually based on how institutions leverage their assets) is approached in both long term and short term goals.  Annual reset is tied to products that do not offer securities, which is often interpreted as a lack of control by financial planners.  Furthermore, there are many planners that do not buy into eliminating the downside of the market in exchange for financial guarantees that come with capped earnings.  They feel their market driven products can yield a favorable return over a period of 30 plus years, as the market has done historically.  I disagree with this philosophy.   The “traditional diversified portfolio” flew out the window when the Fed pumped trillions of dollars into the market in order to offset the financial crisis of 2008, an event that has never happened in US history.  Not to mention many investors do not have 30 plus years to wait the market out, especially with zero guarantees.      

Until investors explore alternatives to Wall Street based products, the fear gage will continue to fall into the red and their financial woes will not be behind them.  The question to ask yourself is how much time and money are you willing to lose before the market corrects itself?  In other words, what is your contingency plan?  Exploring financial alternatives that are designed to protect your money from volatility is key to protecting and preserving your future financial goals.      

Why You Never Want to Break Even on Your Portfolio

With respect to your portfolio, if properly structured, you can have a volatile market work to your advantage.  Many investors today have been lucky to break even over the last 12 years, and the end of the financial crisis is nowhere in sight.  “Stay the course” is a phrase that is finally being second guessed, and rightfully so.

A huge misconception of long term financial growth is that if you’re able to somehow regain all of your previous losses, you’re back to even. The mistake people make in thinking this way is to discount the effect of triple compounding interest.  When you fail to earn any interest over a decade, you also delay reaching your ultimate goal by at least ten more years.   For example, I have had many investors (now clients) tell me that over the last decade they did not take a hit because their portfolio was able to regain the losses they sustained, and they were content on breaking even.  It’s true that their principle balance did not lose value; however, it did not gain any value either.  This is why the last decade is commonly referred to as the lost decade. 

Once you factor in the loss of interest, there is plenty of evidence why you cannot afford to have another lost decade.  When volatility causes you to break even over a period of 10 – 12 years, it’s like those years never existed, metaphorically speaking.  Let’s consider the rule of 72 that was created by none other than Albert Einstein (yes, Einstein helped in the financial world as well) that says if you divide your interest rate X by the number 72, the answer will tell you how many years it will take to double your money (assuming triple compounding interest).  So if you consistently averaged  a 6% return, it would take you 12.5 years to double your money using the rule of 72.  By way of comparison, if your break even or you return is zero, you will never double your money.  Unfortunately, many investors over the last 12 years have been lucky to break even.  There are many publications on this subject.  One that sticks out in my mind was designed by Wells Fargo in November of 2011 titled “The new retirement age is 80, not 65”.  Wells Fargo surveyed a pool of people and determined that due to economic conditions, the traditional retirement age of 65 is now being bumped back to age 80.  This trend is very likely to continue. 

With volatile times ahead, it is extremely unlikely to have the consistently higher average returns on your money needed in order to offset this lost decade.  I’m of the opinion that this next decade could very well be more volatile than the last decade.  Those who choose to just “stay the course” and not explore viable alternatives can very well experience the same damaging effects of breaking even that they had over the last 10 – 12 years.  If you compare volatility over the last 10 years (the stock market) to a concept known as annual reset, there is no comparison.  We all know that this last decade was an unlikely event in the stock market, and returns in the market show promising results over a period of 30 – 50 years.  However, the Federal Government has never had to intervene with trillions of tax payer dollars in order to correct a market downturn.  The truth is most investors don’t have 30 – 50 years to wait in order for their goals to be met; especially with zero guarantees in a volatile market.  

So now we ask “What are the viable alternatives”?  Many investors are turning to annual reset in order to bypass expected volatility.  Annual reset is a core financial concept that allows you to earn a portion of the market upside while eliminating all of the market downside.  Financial institutions that provide this are able to do so because they are prohibited from leveraging assets, and instead are required to hold cash reserve pools to protect the investor’s money on a 1:1 basis.  Through this philosophy, the investor can exempt all future market volatility in exchange for moderate returns.  Earnings using this philosophy are typically capped in exchange for the financial institution absorbing all of the market risk.  If you look at annual reset over the last 12 years on a $100,000 example, many products that implemented this concept outperformed the S & P 500 by over $60,000 (contact us for anillustration).  Investors that adopted this philosophy, especially prior to the financial collapse in 2008, have not missed a beat in achieving their long term financial goals.

To recap, through annual reset investors are able to eliminate the market downside while taking advantage of a portion of the market upside.  These financial guarantees (guarantees of never losing a penny of your money to volatility) are possible through cash reserve pools put in place to protect the investor’s money.  Assuming the next decade is any reflection of the last 10 years, billions of dollars of investor money will be protected while receiving a moderate return.