A couple of weeks ago, I read that one of the instructors at the running of the bulls in Pamplona, Spain had been pinned and gored. It made me wonder, with the lack of boredom in the markets this summer in capital markets across the world, if we might be headed for the goredom of a volatile autumn.
Something’s up when even the instructors in Pamplona are in trouble, just as analysts have been mostly wrong so far this year, especially in the bond market. I now remember why the good man Webster put the first four letters in the word “analyst”. So what makes investors chase all-time highs while 40 percent of affluent investors
have no intention of marrying this market, according to the Investment Management Association? The same urge perhaps that make dogs chase cars and bulls chase matadors - they have no intention of driving and leaving bloodless.
Constant ratio averaging, including the use of savings options like indexed annuities
, may offer an exit plan in a summer where traders are not heading off to the Hamptons for a day away. Volatility indices have increased dramatically recently and perhaps the use of this underutilized allocation tool can help.
Let's say for arguments sake that you have $30,000 to invest semi-annually and allocate one-third ($10,000) of the money in a momentum stock growth fund. The remaining $20,000 is invested in a flexible premium fixed indexed annuity with an annual point to point cap of $3.5 percent. The growth fund declines over the course of a year by 5.5 percent, leaving $9,450 in the account. Meanwhile, the saver gets the benefit of an index annuity that is linked to a value-oriented dynamic allocation index and caps out receiving the full benefit of 3.5 percent. Now the client has a balance in the annuity of $20,700.
There have been numerous years, according to Callan and Lipper analytical, where value has outperformed growth and vice versa. Of course, the index annuity has surrender charges that the mutual fund may or may not have. At this point, we surrender utilizing our 10 percent free withdrawal feature $700 of our taxable gains from the index annuity and add it to the balance of our growth fund. Now our accounts are balanced again at our original allocation.
For the moderate risk taker who wants to carve out gains and buy low, this may represent a viable strategy. When the market is constantly going up as we have seen for much of the last five years, it is difficult to beat a buy and hold strategy
. When the market goes down, the constant ratio concept enables us to maintain a discipline of buying low and creating tax losses that can help us at year end, but also enabling us to move nervous Nellies into a more conservative alternative if their risk tolerances shift like the wind in turbulent markets and headwinds.
Of course in a rising market, the opposite strategy can be utilized to capture capital gains and savor them in perpetuity by moving them to an indexed annuity.
I saw a sign on the back of a plumbers truck the other day that said “We repair what your husband fixed.” Realized capital losses like we saw early in the millennium and as recently as 2008-09, are not fixable and the constant ratio strategy including an option that can provide a lifetime income stream is just one of many risk management strategies to help with the tax man at year end and put some duct tape on losses. At a time when the S&P sells near the same multiple that it did in 2000, according to Standard and Poor’s, now may be the time to apply a little duct tape to one’s portfolio.