Given the stock market history there is a high likelihood that it will recover eventually but the time frame is always unknown. Many of today’s boomers have not saved enough for retirement and any down turn creates a high level of fear because the clock is ticking and no one is getting any younger. So what can be done right now to protect and grow assets for future retirement?
First, there are two concepts that need to be discussed. What is the difference between short term and long term money and the best and worse places to park these funds? Short term money is liquid funds you need for emergencies such as short term unemployment and life’s unexpected occurrences. Short term money is liquid. Short term money should be parked in a safe guaranteed place. Safe guaranteed places can be FDIC insured bank accounts such as laddered Certificate of Deposits (CDs) and Deposit Bank Money Market accounts. Long term money is funds that won’t be used for at least ten years. This money should be parked in long term investment accounts. It is a mistake to park long term money in CDs or Money Markets for two reasons: low rate of return and interest is taxed as earned. Unless you are very near to retirement and will be drawing on this money in the next five years one should not keep long term money in these accounts. If you are worried about investing directly in the stock and bond market, in investments like mutual funds, here are some solutions. I have strategies that have a very high likelihood of success and are easy to implement for one’s long term safe retirement money.
Annual Lock in Reset Concept
What if I told you that you could open a ROTH IRA or ROTH 401(k) and this account had no limit on funds that could be invested AND there are no income limits that disqualify you from opening this account? In addition what if you had a roll over 401(k) or self-directed IRA in which you could not lose your principal but had some upside market return potential. Welcome to the new world of annual lock in reset concept. There are investments that act just like either a ROTH or Traditional IRA that have principal guarantees and market returns without the downside of market loss. Here is how the concept works.
A lot of financial advisors recently have given up trying to select the best mutual fund to recommend to their clients. Most stock based mutual funds are judged against the performance of the S&P 500 index. Each year many mutual funds advisors earn bonuses based on how well their fund performed when compared to the S&P 500. 30% of the mutual funds do better than the S&P 500 each year with only one problem - the mutual funds that make up this 30% are not consistent each year. It is hard to pick the funds that will be in the 30% because you will be wrong 70% of the time. The other problem with mutual funds is that the manager is paid a percentage of the return on the funds and this can be expensive. Many financial advisors have concluded, eliminate the manager and invest directly in an index based mutual fund. Since the industry is based on the S&P 500 why not just buy a mutual fund that mirrors this index without the high expense of an active manager. The annual lock in reset concept takes this one step further.
Instead of investing directly in the S&P 500 index just buy a Call Option to get a piece of the index return if it is positive without incurring the down side risk if the index loses value. The yield on the money invested is the only portion that is at risk not the principal. An example of how this works would be buying an option on a piece of real estate. Assume you have $50,000 in the bank that you are saving to purchase a home. You have earned $2,000 in interest on this money. You find a home that you are interested in but you are uncertain about buying in the current market. You offer $2,000 for the option to buy the property in 12 months for $250,000. The seller accepts your offer because he really needs the $2,000 now. In 12 months you determine if you want to exercise the option to buy. The seller keeps the $2,000 regardless if you buy the property. If the market has appreciated you buy the house. If the market has decreased you let your option expire. All you have risked is the yield on your money not the principal. This is how annual lock in reset works as well. I have included a slide from a seminar presentation I give that shows how annual lock in reset works when compared to directly investing in the S&P 500 index. This is a snap shot of hypothetical 3 year period of time.
The first year the S&P 500 gains by 10% therefore the $100,000 investment is now $110,000. If you are invested in an annual lock in reset, then this gain locks in and becomes principal. This is not the case if you are in an indexed mutual fund. The second year the S&P 500 loses 10%. If the annual lock in reset investment has a minimum credit of 1%, then you get the 1%. But if you are directly invested in the index, then your entire account will lose the 10% and in this case have only a principal balance of $99,000. In the third year if the S&P 500 gains 5%. The annual lock in reset account is credit the 5% and again this gain locks in as principal. As you can see that over this three year period the lock in reset account has a spread of 13% over directly investing in the index.
While the annual lock in reset concept is probably the best safe investment one can have for long term money there are some caveats. If one invests directly in the market their investment will raise and fall with the market. For example, in a year where the market experiences a 25% gain their investment will be credited with this entire gain. In these years the annual lock in reset concept will have a much lower return because the market gain will always be capped anywhere between 6.5% to 15% depending on the investment. Conversely if the market experiences a 25% loss the money invested directly in the index all the money is at risk for this loss. In the annual lock in reset only the yield on the money is at risk never the principal so in a market decline either 1% or 0% is credited to the account. Over time the annual lock in reset is a safe place to keep some of your long term money and it should yield respectable returns with very limited risk. In addition these investments if funded properly can either be entirely tax free in your retirement years like a ROTH or tax deferred like a tradition IRA. Lastly many of the traditional IRA like accounts offer up to a 10% bonus on money invested – this might help make up for some of the losses already experienced in the current market.
DOW JONES INDUSTRIAL AVERAGE RECENT HISTORY
• August of 1987 highest close 2722.42 and October of 1987 lowest close 1738.74 -36.13%
The DOW fully recovered these losses by October 1989 close of 2791.41
• January of 2000 highest close 11722.98 and October 2002 lowest close 7286.27 -37.85%
The DOW fully recovered by December 2006 with a highest close of 12510.57
• October of 2007 highest close 14164.53 to Present October 16, 2008 close 8786 -37.97%
When the DOW will fully recover and move past this recent high is unknown.
STANDADRD AND POOR 500 INDEX
• September of 1987 highest close 321.83 and October of 1987 lowest close 347.08 -23.23%
The S&P fully recovered these losses by October 1989 close of 353.40
• March of 2000 highest close 1498.58 and September of 2002 lowest close 815.28 -45.60%
The S&P fully recovered these losses by late 2007 close of 1526.75
• September of 2007 highest close 1526.75 to the present October 16, 2008 close of 929.13
When will the S&P fully recover and pass this recent high is unknown
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