Why mutual funds can’t protect against a stock market crash
By Roccy Defrancesco
The Wealth Preservation Institute
I recently saw that the stock market was crashing due in part to the government shutdown and the looming debt-ceiling extension, and I thought it was the perfect excuse to talk about how it’s nearly impossible to protect money from a crash if it’s invested in most mutual funds.
The fact of the matter is that most Americans use mutual funds for some part of their investment portfolio. This, of course, is because we have a broker-dealer-driven industry.
If you’ve been reading my recent articles, you know I’ve been trying very hard to change the discussion in our industry from using historical rate of return to investments to asking the following much more important question: What risks are you taking to achieve your expected rate of return?
Mutual funds stay invested in stocks, even when the market is crashing
Most investors don’t know that most mutual funds stay invested in stocks even when the stock market is crashing (and most advisors who sell mutual funds don’t seem to think about the ramifications).
Don’t believe me? Go to www.finance.yahoo.com and look up the symbols of two of the more popular mutual funds. On the profile page, you can find the percentage (%) of how much each fund is invested in the market. I’ve listed it for these two funds.
-FBGRX (Fidelity Blue Chip Growth) 80 percent invested
-AEPGX (American Funds EuroPacific Gr A) 80 percent invested
-FBGRX: 2008 = -38.60%; 2002 = -25.32%; 2001 = -16.55%; 2000 = -10.54% Total losses = -91.01%
-AEPGX: 2008 = -40.53%; 2002 = -13.61%; 2001 = -12.17%; 2000 = -17.84% Total losses = -84.15%
Because the mutual funds themselves do not protect clients when the market is crashing, who does that leave to protect the client? The local financial planner. Is it realistic for a local advisor to recommend that clients go to all cash? That would be nice, but most think they already did their job by picking the “best” mutual funds. Using tactically managed strategies
How would your clients have liked the following returns during the crash years?
2008 = +8.03%; 2002 = +7.04%; 2001 = +7.55%; 2000 = +2.07% Total returns in crash years = +24.69%
If this article doesn’t make you wonder if mutual funds are the best place for your client’s money and consider learning about truly tactically managed strategies, then I have failed.
Alternatives to mutual funds
What are the logical alternatives to growing wealth with mutual funds?
1. Tactically managed investment strategies — These are strategies that are managed to limit downside risk and capture gains in up markets. One of my favorite managers has a 21-year audited track record of no down years and net returns in excess of 9 percent. So, for the money a client should have “in the market,” being in a tactically managed strategy is the way to go.
2. Equity indexed universal life insurance (EIUL) — As many of you know, this is one of my favorite wealth-building tools for clients under the age of 55. Gains are locked in, no downside risk due to negative markets, tax-free loans, etc.
3. Fixed indexed annuities (FIAs) — I don’t like to say FIAs are a replacement for a market driven portfolio; it’s comparing apples to oranges. However, especially for clients 55 and old, using an FIA (especially those with guaranteed income riders) can be a much more prudent decision than using what most financial planners would recommend — an asset allocated portfolio.
Mutual funds will not protect your clients’ money during stock market crashes. They need to know this so they can make informed decisions about whether to use them or whether they should seek out other tools to grow their wealth in a truly protected manner.