In this episode of Retirement Unpacked, Al Smith delves into the insights of Nobel Prize winner Daniel Kahneman, focusing on the psychology of loss and gain in financial decision-making. Discover how the emotional impact of losing money far outweighs the joy of financial gains, and learn how this principle guides retirement planning. Al explains the complexities of buffered ETFs, a financial product designed to mitigate risk while navigating market volatility.
Welcome to Retirement Unpacked with Al Smith, owner of Golden Eagle Financial. You want a retirement plan that alleviates your fears about the future so you know your money will last. As a chartered financial consultant, Al Smith will help you find a balance between the risk and reward of the market and the safety of your retirement income. And now, here’s your host, Al Smith.
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Welcome to another program of Retirement Unpacked. I have some good information for you this afternoon, and if the information that you hear is something that you’d like to learn more about or how it can affect you and your retirement savings, then call my office and we can have a long phone conversation or a Zoom, or you can stop in, have a cup of coffee, and we can have a conversation and see if you’re on track for your own retirement. What we’re going to talk about today has to do with an economic Nobel Prize winner named Daniel Kahneman. He won the Nobel Prize. His background is in psychology and economics. And if I were to distill what his research has shown, it’s that the psychology of people is such that people hate to lose much more then they like to win. For example, his research showed that if there were some experiment or something where someone had the chance of losing $100 or possibly winning $100 in some kind of game of chance, and so forth, they would radically avoid losing the $100 with much greater emotion than the possibility of earning $100. So essentially, the psychological pain of losing money is twice as great as the pleasure you feel when you make a profit. And since we’re here talking about financial things in the financial markets, that’s extremely important. And today, this afternoon, we’re going to talk about mitigating risk. And mitigating risk is a little bit like anything else. There’s positives and negatives. And if you want to still have your money grow but have less at risk, then there’s always going to be some kind of tradeoff. The tradeoff might be a little bit less growth. The tradeoff might be your money isn’t quite as liquid in a particular product that is safer. Or there may be some features of a particular product that is safer that makes it a little bit less attractive. Feelings are much stronger about not losing money than earning money. So with respect to this tradeoff, there have been products that have been developed to mitigate risk. And that’s what we’re going to be talking about this afternoon is mitigating risk. There is an ETF that has come about relatively recently, like within the last 20 years or so. And right now, there are 200 funds and $43 billion in assets that are in what are called buffered products. And you’re thinking, well, what are buffered products? Well, first of all, they’re ETFs, and an ETF is an exchange traded fund, which is like a mutual fund, but exchange traded funds have lower costs, and they can be sold throughout the day. in the market. Stocks can be sold throughout the day, but mutual funds can be sold only at the end of a trading day. That’s one of the differences between mutual funds and ETFs. But let’s take a look at what they actually are. actively manage strategies that require some explaining. They’re not typical stock or bond funds. They’re something in between, more like what we would call alternative investments. And buffered strategies aren’t new. They’ve been around for a number of years in mutual funds and in annuities. But the first funds that came about for those are First Trust, Allianz, IGM, PGIM, and so forth. And they have It requires kind of a lot of explaining to what they are. They’re not a typical stock fund or a bond fund. And essentially, the way they work is that the term buffer means your losses are limited. But in exchange for having your losses limited to a certain buffered amount, there is also a cap on your growth. So like any other financial product that mitigates risk, buffered income. Exchange-traded funds have certain caps, and they have certain what we would call floors. And they have a variety of risk and reward combinations. The majority offer a certain cushion on losses over a 12-month period in exchange for giving back some of the gains. Some of them tweak the formula a little bit. Others focus on just the downside protection. With 200 different funds out there, there’s obviously quite a large selection, and we’re not going to talk all afternoon about buffered ETFs, but they are a way to mitigate risk. And the way they do that is by having a cap and a ceiling. And you’re probably wondering, well, how do they work? Well, most of them are linked to the Standard and Poor’s, which is the index of the biggest U.S. companies. It represents about 80% of the economy of the whole contract. And the fund managers, they define how much protection to offer on the downside, which is called the buffer, and they set the limit on the upside, which is the cap. And the way they do that is they invest in option contracts. which allow them to buy or sell shares in an S&P ETF at a set price on or before a certain date. The most common type of buffered exchange traded fund has a 12-month outcome period. the range of possible returns are defined by the option contracts that the fund holds. And I don’t want to get too far into the weeds, but essentially, let’s take an example. Investors who bought shares in a particular buffer ETF in the beginning of 2024, they might have a 9% buffer against losses. And what that means, if the market goes down 10%, they would only lose 1%. If the market goes down 20%, they would lose 11%, because 9% is the amount of that buffer. Okay, so losses beyond 9% aren’t protected. But that particular buffered ETF may also have a cap of, let’s say, 15%. So basically what that is saying, if the S&P grows by 30%, 40%, this buffered ETF would only return 15. But if it went down 20%, the owner of this ETF would only lose 11%. So essentially, it mitigates risk by mitigating the volatility. so to speak. Now, there’s disadvantages of these particular products. Cost is one. They have an expense ratio of about three quarters of a percent, which is a bit higher than other ETFs. Not that significant, but it is something to consider. Consider also the timing of the purchase needs to be done properly in order to have attractive terms because the terms which are the amount of the buffer and the amount of the cap those vary periodically, and these are like 12-month products. And as each buffered ETF becomes available, then some are more attractive than others, depending on the cost of the options and things like this. Again, I don’t want to get too far into the weeds, but essentially let’s look at a period of time where maybe the S&P has gained 20, 30 percent. I know in years 23 and 24, those were really good years. But in 2022, that was a big down year. The S&P lost about 18 percent. Well, to give an example, two buffered ETFs, one of them, when the market, based on the S&P, lost 18%, it lost only 7%. Another one lost only 4%. But conversely, in the following years, when the S&P did well, the growth in that particular exchange traded fund was limited. So I would say buffered ETFs are for people who want to mitigate their risk and limit their risk, and they are going to be okay with a more modest level of growth in exchange for that buffer on the downside. Now, there’s a lot of reasons that these are quite attractive. And some buffered ETFs, for example, instead of having a cap on the top side, they will have a cap, let’s say, on the first 3% of gains. So that means if the market grows by 10%, You give back the 3%, so your account would only earn 7%. But if the market grew by 30%, your account would grow by 27%, because instead of that cap, the cap is the first 3% of growth. So these are, I would describe them as complex products, but they can fit into people’s portfolios, primarily people who want to mitigate risk, limit the risk. And these vary enormously. And if you would like to learn more about these and how they work, we can have a conversation at my office. And we can have a long phone conversation, a Zoom call, or a meeting in my office. And for people who are working, I work late into the afternoon and early evening to accommodate folks who are working and trying to save for their retirement. There are additional upsides to buffered ETFs. They can really fit in well with people as they move closer into retirement and want to have a more conservative approach to how their money, how their funds are allocated. And there are other ways of mitigating risk, which we’ll talk about after the break.
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Al Smith of Golden Eagle Financial knows that the biggest threat to your retirement isn’t what you expect. It’s what you don’t expect. That’s why Al doesn’t just help you save. He helps you plan for the unknown. Things like long-term care, emergencies, and hidden expenses that people never see coming. And he understands the role that each product investment and strategy can play in your financial plan. Al starts with your vision for retirement and he works backwards. creating a plan that incorporates more than just a savings account. Because a successful retirement takes more than just money. It takes specialized strategies from someone who knows what tools are available and how to prepare you for each stage of life. That’s why so many of our listeners trust Al Smith of Golden Eagle Financial to tailor a plan that keeps their specific future in view. So get started on your financial success with Golden Eagle Financial today by sending Al a message on klzradio.com slash money. Investment advisory services offered through Brookstone Capital Management LLC, a registered investment advisor. BCM and Golden Eagle Financial Limited are independent of each other. Insurance products and services are not offered through BCM, but are offered and sold through individually licensed and appointed agents.
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Welcome back. We’ve been talking about mitigating risk, structuring your portfolio in such a way that you would not be as severely affected if there were another ugly situation. market downturn such as we experienced in 2008. And first half we talked about buffered product and the word buffer means a limitation of loss. Your account is buffered, so to speak. There are other financial products, and these are products that are in the market. They are not insurance or annuity products. We’re talking about products that are in the market. And the next one we can talk about briefly is structured notes. And structured notes are put out by big banks, investment banks, such as Morgan Stanley, BMO, which stands for Bank of Montreal, Bank of America, other big financial firms, Goldman Sachs, they also put out structured notes. And to give you an example, the way some of those work, there are what are called flash notes. And flash notes, first of all, these are offered, and they are either like a one-year or a two-year product. So your money would be tied up for a small period of time, one year or two years. And a flash note, for example, might pay a certain rate of interest, let’s say 10 or 11%. every month, and it could be added to the note or distributed. And the only way you would lose or have any of the money that you put into the flash note subject to loss is if the underlying Accounts which would include like the S&P, the NASDAQ, if one of those were to drop by 70% or more anytime during this one year period. And that is called the American style of measuring flash notes. So as long as the market doesn’t drop by 30% or more, that 10 or 11% interest is paid every month. There’s another way of measuring these. which is called the European style. And with this kind of flash note, it pays slightly lower interest, but the only way there would be risk is if the market were 30% lower at the end of that one-year period than at the very beginning. Whereas the American style is if it were 30% lower any time during that one-year period. And since the European style has lower risk, the return is also lower. And these come out periodically. They come out like every month. They’re 12-month products, and some people invest in these, and when the 12 months is over, they reinvest and so forth. And the money is not nearly as liquid as one might like, but the returns are attractive, and there is also something called a growth note. That’s where, instead of paying a return, a growth note may have what’s called a call option. That’s where the bank decides they want the money back. Well, if that’s the case, that has to happen within the first year of the growth note, and they would have to pay a premium of 9.8%. Assuming the note is not called, one of these growth notes, if it were linked, for example, to the NASDAQ, may have a participation rate of up to 120, maybe even 150 percent of the growth of the NASDAQ over that one year period. It also includes a 15% buffer. So what does that mean? Well, let’s say, for example, if the NASDAQ grew by 20% over the course of one year, at the end of one year, your account would yield 30%. On the other hand, if the NASDAQ dropped 20% over the course of that year, because this includes a 15% buffer, if the market dropped 20%, you would only lose 5%. If the market dropped 10% because you have a 15% buffer, your account would not lose at all. And so structured notes, which include flash notes, growth notes, there are even notes that completely guarantee principal, but the returns on those are much lower. But these are one tool to mitigate risk. And again, this is in the market. Now, one of the things that some people recommend is as people get closer to retirement and they move into and through retirement, there should be a balance there. between equities and bonds, money actually purchasing stock versus loan products, which are bonds. And there is a rule, and I’m not saying I favor this, but it’s a rule of thumb, which is a bad term to use, but they say subtract your age from 100 and that’s the percentage that you should have in equities. So if someone is 50 years old, they should have half of their money in equities and half of it in bonds. If someone’s 70 years old, they should have 70% of their savings of their investments in bonds and 30% in equities. Now I’m not saying I agree with this, but it is a tool that’s used by some people. What I would prefer, because the fact that someone is a certain age doesn’t necessarily mean that equates to a lower level of risk just because someone is older. Some people who are older have investments that they don’t actually need the income that they’re generating for their income. So some people are comfortable with a higher level of risk, even if they know it’s likely to be part of their legacy and passed on to their children and grandchildren. Other people who are older have investments that they totally rely on to generate income that they need to maintain their standard of living in retirement. I would clearly say people who fall into that category would have a lower level of risk and would probably want a higher percentage of income. his or her or their nest egg in bonds for that reason because when the market tanks, bonds usually hold their own so to speak. And although I don’t deal in it personally, a lot of people invest in precious metals as a hedge against both inflation and market volatility. Some people also have significant amounts, like money markets. Now, as long as you can get a reasonable return, I don’t think that’s a bad idea. I think most people should have a reasonable amount in savings for emergencies. They say you should have six months income in savings. And I just heard recently that Huntington Bank is paying 4.6 in their money market if the amount invested or deposited is $25,000 or more. So there are ways to mitigate risk that are 100% safe with modest returns like money market accounts. Also, annuities for a modest amount of people’s nest egg makes sense because most annuities, with the exception of variable annuities, are protected against risk. They’re protected against downside. They are less liquid than money in the market. Some of them even have what’s called an income benefit benefit. that will pay a lifetime income for as long as the person is living or for as long as he or she and their spouse is living. And whether that’s a good idea or not depends on someone’s circumstances because these income benefits, they provide the certainty, even if someone lives to be 102, and their account balance goes down to zero, these income benefits would continue. And if that’s something that you’re considering, I would suggest that you look at different carriers because with some of them, it includes fees. With some of them, there are no fees. And with some companies, the level of income is higher than with others. So it’s important that those be looked at and evaluated carefully. So sort of in conclusion or to summarize, if you are totally in the market and you’re okay with risk, you can achieve some extremely good returns, especially when the market is doing well. In 2023 and 2024, both the S&P and the NASDAQ did extremely well. In 2022, both of those indices went down. So it’s necessary to stay in the market to enjoy the growth. And there are tools available. that you can take advantage of if it’s your goal to limit or mitigate your risk. And if this is something you’d like to learn more about, call my office 303-744-1128. And let’s continue to pray for the folks who’ve suffered recent disasters, the families of the children up in Minnesota with the school shooting and some other things that have been going on too many times. ugly things even to talk about but let’s pray for our political leaders our country peace in the middle east and hopefully you’ll be here next week and i will have some good ideas for you bye now
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But are offered and sold through individually licensed and appointed agents.
