equity indexed universal life insurance | Financial Solutions for Doctors in Private Practice

Why Mutual Funds Can’t Protect Against a Stock Market Crash

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

The by-product of being invested in the market with 80 percent of the fund’s assets is that when the stock market crashes, so does the mutual fund. In other words, the fund managers will not go to 50 percent, 75 percent, or 100 percent cash, even if they know the stock market is crashing. It’s proven true by the numbers. Look how each of the above funds did during the crash years of 2008, 2002, 2001, and 2000:

-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%

It’s crazy to think that these and many other mutual funds would stay invested in the market when it’s crashing, but that’s the reality — a reality that most clients are unaware of.

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%

These returns look a lot better than the negative returns of the above-listed mutual funds. Would it help you to know that the tactically managed strategy with the above listed returns has not had a down year in the last 21 years and has had an average net rate of return in excess of 9 percent?

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.

Bottom line

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.

Has Your 401K Become A 201K?

Leave a Comment / September 22, 2011

Has Your 401K Become A 201K?

On September 22nd, the Dow Jones Industrial Average fell another 390+ points. Proposals by President Obama have fallen flat and nobody was impressed by the latest moves by the Federal Reserve. The U.S, Congress has not come up with a plan of their own and it appears unlikely that any plan could be passed given the inability of Democrats and Republicans to compromise on anything these days. There is no functional leadership in control of the Nation.

Our future looks even bleaker when you consider that most of the Republican candidates for President look like extremists that will be difficult for many Americans to support at the polls next year. If the Republicans don’t beat Obama next year, we’ll be in worst position than when he took office in early 2009. He’s already shown that he has no answers for the problems of the country and has even less ability to get his ideas passed.

As a result of all this, your retirement accounts have probably been dropping lately. Interest rates are at record lows, so money placed in savings accounts and CD’s have never earned a lower rate of return. Many accounts invested in stocks or bonds have been subjected to extreme volatility and may be on the way back to levels seen at the worst times of 2008. Is there anything you can do to protect the money you’re going to need for your retirement? Yes, depending on your age, there are two possible solutions.

If you’re within 10 years of retirement, a retirement annuity may be just what you need. You’ll need to talk to a licensed life insurance agent to be sure, but a fixed or indexed annuity can offer the safety and security of bank accounts and CD’s while offering a much better rate of return. Best of all, it’ll provide a guaranteed income for life when you retire, no matter how long you live. Most retirement accounts can be invested in a retirement annuity, but please understand that they are not for everyone, so make sure you work with somebody you can trust.

If you have more time, or are actually just starting out, it might be better if your retirement account was an indexed universal life insurance policy. This is probably the most misunderstood financial tool of all but, in recent years, these policies have outperformed many stocks-oriented funds and indexes while offering a guaranteed floor that protects you from loss due to market fluctuations. For many people, this is the best of both worlds (safety with good returns), but it has a very big kicker – if set up properly, an indexed universal life insurance policy can fund your retirement with a TAX-FREE income for life! Yes, it’s true that money invested in your “qualified” plan (IRA, 401k, etc) gets a tax deduction in the year it’s invested but, if you do the math, you find that the tax break you got while working is quickly offset and more by the tax-free income you can get from a life insurance policy.

If this is news to you, then you need to speak with your life insurance agent ASAP. If you live in Southern California, give me a call (714-585-2371) or send me an email (EquityIndexLife@gmail.com) and we’ll have a private conversation with no obligation for you to buy anything.

Does Deferring Taxes to Retirement Make Sense?

Leave a Comment / June 30, 2011

Does Deferring Taxes to Retirement Make Sense?

One of the basic premises of putting money into a tax-deferred vehicle like an I.R.A. or 401(k) is that you are likely to be in a lower tax bracket after you retire. The presumption is that your income during your retirement years will be lower and the tax rates will be the same. But does that really make sense?

Currently, thanks to the tax cuts pushed early in the G.W. Bush years, income tax rates are pretty low by historical standards, especially the rates for capital gains. The big question is – Will they stay that way?

Governments at all levels (federal, state, local) are currently having trouble paying their bills. The combination of a bad economy coupled with exorbitant pay and benefits given to government workers has led to a lot of deficit spending that cannot continue. This has caused most government levels into draconian spending cuts in education, court services, and benefits for the poor and disabled. It seems unlikely that these cuts can increase. What’s the alternative? Tax increases!

It seems to me that we’re likely to see major increases in tax rates in coming years. In some states, it’s not easy to raise tax rates (like California), but I don’t think we should ever underestimate the resolve of politicians if they think they’ll take less flak for raising rates than for cutting benefits.

So, if tax rates are likely to increase in the future, does it make sense to defer taxes from the present, when rates are lower, and pay them later, when rates are higher? Logically, it doesn’t make sense unless the difference between your current income and your income at retirement will be large enough to offset the difference in tax rates.

It used to be that retirement meant something different than it does today. When you retired, your house was paid off, you had few debts, if any, and you expected to live a quieter and less active life. From everything I read today, that’s no longer the case. For many of us, we’ll simply spend a little less time working while exploring our “bucket lists”. To the “baby boomers” who are now retiring, a major drop in income is not in their planning. Which brings us back again to the question – should you be deferring taxes from today to the future, when income tax rates are likely to be higher? To which I would add – Is there a valid alternative?

I believe there is. There are products available today that will allow you to save after-tax income from today, compound it free of income taxes at a good rate of return, then spend it later without income taxes. Think of your current income as a small box. Imagine your savings from that small box, compounded tax free over a period of 20-25 years. Your savings plus interest after that period of time is a large box. The question is – would you rather let the government tax the small box now or tax the big box at higher rates later?

What is this product that will allow your savings to grow free of taxes, then be spent tax-free later? Equity indexed universal life insurance. This is not your daddy’s life insurance! For more information and a no obligation consultation, give me a call at 714-585-2371.