Market Risk
First of all, Market Risk is undoubtedly the risk that you understand well. You know that you have to both grow your retirement assets and protect them from down markets. We’re in somewhat of a historical time where this is challenging to do.
If you will look at a graph of the S&P 500 total return including dividends tracked from the beginning of this century in 2000 to the end of 2021, you will see a fluctuating market. When someone says, what did the market do today, the S&P 500 is usually one of the indexes they are referencing. At the beginning part of this century, we had the dot.com bubble burst where the market dropped for three straight years. Then, in the middle part of that first decade, we earned our way back out of that rut. Then in 2008, what happened?
Mortgage crisis. The market plunged again. Lost almost 40%. Gave back all those earnings and since then, truly, the market has been on a historic bull run.
But while people remember the market returning 20%, 14% and more in recent years, on average, over that time period, the returns have been about 7.45% I’m not saying that’s high or low, good or bad, that’s just the average annual return for this century.
Keep in mind, that return is before fees and before taxes so the actual money you are able to access from those returns is significantly less. But volatility in the market can have a big impact in long term savings rates, but it’s especially challenging because we simply don’t know whether you will be retiring in the 2021 up years or the 2008 down years.
A great example of this is just a short time ago when the Covid Pandemic hit and the market reacted dropping suddenly and significantly.
What was interesting is not just that drop, but if you measured the entire century’s average S&P 500 return in March rather than January 2020, suddenly 21 years of market experience had gone from an average return of 6% per year to an average of 4.42% Two weeks of market volatility during Covid had taken over a percent and a half off a twenty-year average return. So we know that the market will continue to be volatile and that volatility can have an impact on long-term earnings rates.
Now as you age, you are not going to keep all of your funds, I hope, equities-exposed. That’s why we have diversified portfolios and particularly why as you age, you tend to move toward more secure savings vehicles.
The challenge is in chasing some safety, interest rates are still at relatively historical rates.
Now why is that and why do interest rates skew relatively low and why are rates likely to continue this way in the course of our lifetimes?
Well, our government is sitting on a $32 Trillion debt. The US government owes so much money that that’s going to naturally have to keep a little bit of a cap on how high interest rates can go. What this means is that we are in a very unique point in history. Your grandparents, for example, might have been able to fund their retirement off of laddered CD’s , but if you’ll notice, today it is very challenging today to get a return on a fixed income instrument that even has some meaningful growth on the left side of the decimal point, right? We’re seeing a lot of 0’s.
Secure fixed income vehicles simply cannot fund our retirement the way that they could for past generations which means that we have to take more market exposure to get where we need to be.
And what that means for savers today is that we’re faced with something that I call the saver’s dilemma. And it’s very unique in our history. It is this realization that if we went to grow our funds, we have to accept the risk of a volatile market. If we want to protect our funds, we have to give up meaningful growth opportunities. So there is a constant tug and pull between those two choices.
Now, we can address the saver’s dilemma one of two ways: the first is we can mitigate it through allocation. And this is traditional financial planning, right? We’ll put a portion of our assets in the market and a portion of our assets in fixed income. We’ll re-balance that as we age, but allocation is not the only way to address the saver’s dilemma. We can also mitigate it through product design.
And this is where Indexed Universal life or IUL offers something really unique in addressing your market risk challenge. Let’s assume an index with an 11% cap. As I mentioned before, in the beginning part of this century, the market fell for three straight years, but the index helds its own not losing any money in the down years; simply returning 0.
Then, as the market grew, the index grew along with it up to the 11% cap. And that growth over time and because of that 0 floor indexing, can provide an attractive pattern of the return without the rise and fall of the market. It allows us to access growth opportunities like we would want from equities, but also the security and safety like we want to access from a fixed income.
Thinking of market stability, this story comes to mind:
And it’s a story of a husband and wife that are traveling through the Arizona desert to a small resort town. They see a sign that says last stop for gas in 100 miles. And the wife says to her husband, we should fill up the tank. And the husband looks at his wife, checks the odometer and says we’ve got 120 miles until empty, we’re fine and keeps driving. His wife is not very happy. And they pass the next sign that says 80 miles until next gas. And the husband says honey, we have 96 miles until empty. Don’t worry we’re gonna be fine. Fifty miles till gas. Husband says sweetheart, we have 62 miles till empty, we are gonna be fine and we’re gonna make it. Twenty miles to gas. Darling, we have 26 miles till empty. You don’t need to worry. Finally, they pull into the resort town gas station with 6 miles left till empty. And the husband looks at his wife and says See, I told you we didn’t to need to fill up on gas. Well, they go ahead, and they fill up their tank and drive to the resort. And as they’re checking in, the front desk receptionist says, Mr. and Mrs. Smith, Was that not the most beautiful scenery you have ever experienced in your life? National Geographic consistently ranks that one of the top ten drives in North America and I hope you enjoyed it. The husband looks at his wife and the wife looks at her husband and what did they realize? Had they been looking at the scenery? No. They had been looking at the gas gauge.
When you have your money on the market, you are going to spend your retirement looking at the gas gauge. Do I have enough? Will the swings in the market on low-performing fixed income defer my happy retirement?
By diversifying some of your income with indexing, you can have breathing room to instead focus on the scenery because you know you’ll participate in the market’s growth and be protected from the market’s fall.
It’s really a powerful, powerful way to mitigate that market risk that exists in today’s economy.