Money Talks: Diversification, know the details
For investors here in paradise, many are thoroughly enjoying the ride with the recent the stock market gains and all of the mystery that is “The Trump Effect.”
The relevance of the recent market highs, although impressive on the surface, has many behind the scenes convinced there is little substance behind such a drastic and significant rally based on sound economic fundamentals. In other words, there is no legitimate catalyst to rationalize the market other than temporary investor sentiment, which is code for perhaps short-lived and unsustainable.
However, with all of these variables in place, the fact remains that at least for now, the markets continue to set records, although with minute increments, and investors seem to be memorized. Recent gains have many investors seriously considering the value of true diversification; not just more stocks. Generally speaking, in raging markets as the one we are experiencing currently, most assets classes also enjoy success, including the alternative asset class. Now, for the record, “alternative assets” simply refers to an asset class that may not be subject to the fluctuations of the stock markets, in fact, in some cases, there may be zero market correlation, as is the case with managed futures.
As investors, and particularly retired investors, begin to embrace the value of true diversification, now perhaps more than ever it is essential to protect a portion of the portfolio gains with alternatives which may have an opportunity to avoid potential market corrections that may be looming ahead of us. Here is where the attention to details becomes tantamount.
Many have seen the light as it pertains to capturing a percentage of the stock market’s gains while avoiding any and all market based losses. The implementation of an insured index strategy can be valuable in the pursuit of true diversification, however, details matter. For instance, many have considered the much maligned variable annuity as an alternative asset class. The particular details here are twofold; first, it is important to understand that as the name indicates, these accounts can and will “vary” with the stock markets moves, thus the term “variable”. So we can confidently expect fluctuating values with this strategy. However, lost on far too many retired investors are the often excessive annual fees that can come with this particular asset class. There can be considerable insurance costs associated with the already prevalent investment management fees. We have seen, on numerous occasions, variable annuities with annual fees as high as 4.75 percent per year; and no, that is not a typo.
When we do the math, especially in flat or down years with the stock markets, these fees significantly impact the portfolios ability to generate meaningful returns. In other words, the fees can put the portfolio so far behind in various market conditions, the losses are only compounded by the addition of the fees. As it pertains to diversifying with variable products, the details are indeed critical.
For others, there is a safe, stable and predictable insured index avenue which does not participate in any market based losses, and in some cases, charge minimal or even zero fees. These insured index portfolios, as the name indicates, participate in a particular stock index such as the Dow Jones or The S&P 500. Here again, the details are important. The trade-off for avoiding market losses results in muted returns that, although based on a particular market index, may only capture a percentage of the markets gains.
These percentages can range anywhere from 10 percent to as much as 70 percent of the market gains. Again, the critical detail here is that by avoiding market based losses and minimizing the annual fees, this strategy can complement virtually any portfolio. Know the details.
As far as details are concerned, many have embraced the proven track record of managed futures and their ability to potentially outperform stocks, but far more importantly, their ability to generate returns when the stock market is correcting, or even crashing. When the stock markets crashed by roughly 50 percent in both 2002 and 2009, the Barclays TOP50 managed futures index was up approximately 40 percent and 14.5 percent respectively. Yes, details can lead to the life of a SWAN, Sleep Well At Night.
William F. Hague is a managing partner of Hague Wealth Management; 239-389-1999 or WFHague@earthlink.net. The opinions and observations stated above are those of the columnist.