Is another lost decade on the horizon? Why you never want to break even on your portfolioArticle added by Cal Burgess on July 26, 2012
Joined: August 24, 2011
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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 could very well experience the same damaging effects of breaking even that they saw over the last 10–12 years.
If properly structured, a volatile market can work to your clients' advantage. Many investors 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 about 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 10 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 emphasizing 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 as if those years never existed. 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 percent 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, investors are extremely unlikely to seethe consistently higher average returns 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 could very well experience the same damaging effects of breaking even that they saw over the last 10–12 years.
If you compare stock market volatility over the last 10 years 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 to 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. < ahref="http://www.producersweb.com/r/pwebmc/d/contentFocus/?pcID=09e30af530a72bae3e8b7777ac02b1c0' Target="_New">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 more than $60,000. 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 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.
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