Leverage New Solutions and Position Your Portfolio before the Next Storm

Protection and preservation of wealth are of the utmost importance, particularly in volatile market conditions. Consider these steps and products as you build your plan.
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By Corey Walther

One of the most important questions every investor should ask themselves is, “Am I investing within my risk tolerance?” When it comes to financial planning, protection and preservation of wealth are of the utmost importance, particularly in volatile market conditions like we’ve seen throughout the COVID-19 pandemic. This environment clearly requires a different approach to help manage risk.

Corey Walther

Corey Walther

For the thousands of baby boomers who are entering retirement every day, reducing risk to their portfolio is a logical and necessary step in helping to build a more secure retirement foundation. Yet, many boomers aren’t able do so at the expense of completely shunning growth potential, so they are still looking for ways to participate in returns based on equity market performance.

For younger generations, including millennials, managing risk doesn’t seem like it would be as much of a priority because they have time on their side to rebuild from any losses. But this group has now gone through two significant financial crises in just over a decade, with the pandemic and their parents’ experiences during the 2007-2008 crisis still fresh in their minds. These factors have created investors who are surprisingly risk-averse for their age, constantly second-guessing when and how to put their money to work.

So, what are investors to do?

While risk management should never be applied as a one-size-fits-all approach, the following are tactics you can use to address risk while still keeping an eye toward growth potential.

Revisit Diversification

One of the “golden rules of investing” is diversification and evaluating your personal risk tolerance in relation to your long-term goals. You may have already gone through the process of determining your risk tolerance, but given the events of the past few months, it’s a good idea to revisit risk as it relates to your current positions, portfolio holdings, level of diversification and overall investment goals. For many people, it makes sense to work with a financial professional who can understand your individual goals as well as help design and implement a plan that can address a variety of risk factors, including longevity risk.

Other actions to consider include deciding if (or how much) one might work in retirement, determining your optimal Social Security filing strategy and creating a retirement budget. Next, compare your total expenses (both essential and discretionary) with your anticipated retirement income from all sources: guaranteed income (Social Security, pension and/or annuities), variable income from a part-time job or investments, along with any withdrawals from your retirement savings.

Consider Rebalancing

It’s important to rebalance at least annually and make any changes needed after reevaluating your portfolio against your investment goals. As we’re seeing now, a lot can change in a year and it’s nearly impossible to predict how market volatility will affect your portfolio. Every investor should be working with their financial professional to make sure they have the balance and diversification necessary to address risks to their retirement security.

Keep in mind, rebalancing is simply the process by which you maintain your desired balance between risk and return. Failure to rebalance allows the ups and downs of the market to make your portfolio either too aggressive or too conservative, potentially making it harder to reach your investment goals. The good news is that rebalancing doesn’t have to require a lot of effort.

Set a calendar reminder to rebalance once per year. Remember, you don’t have to match your target asset allocation in every single account. It’s your overall asset allocation across all accounts that matters. Any individual account can be different as long as the overall sum adds up. The goal is to determine how much money you should move from stocks to bonds (or vice versa) to get back to your target asset allocation. You can do this by multiplying your target stock percentage by your total investment balance and subtracting that number from your current stock balance. If possible, make any necessary trades within tax-advantaged retirement accounts so that you aren’t taxed on the transaction. Further prioritize accounts that are free to trade in order to minimize costs as much as possible. Once you’re done, set another calendar reminder for next year.

While this process may take a little longer the first time through, you should be able to complete it in no more than an hour once you get used to it. And because you only have to do it once per year, it’s a relatively small time commitment to keep your investment plan on the right track.

Explore Innovative Solutions

Annuities: Exactly which investments to choose and financial products to utilize depends on a number of factors such as your age and specific investment goals. Generally, for many older investors, risk management should be a larger part of the equation. This means having a greater portion of investments in more conservative, less volatile products, as well as solutions that still offer some growth potential with an added level of downside protection. Innovative annuities offering these features should be considered in the retirement planning process as a complement to other portfolio holdings.

For the growth-oriented investor, certain types of buffered annuities can help reduce risk without sacrificing some participation in equity markets. Let’s say you put some money into a variable buffered indexed annuity with a lockup period of six years, and that annuity is linked to the S&P 500 Index. You can then choose an option where you are protected against a loss of up to 10%. That way, if the market goes down 15% in the first year, you are protected from the first 10% of that loss, meaning you’re only on the hook for a loss of 5%. Let’s now say that the market went down 5% that year. You lose nothing in this case. The insurance company incurs the full loss because you are protected up to 10% for that year.

The trade-off? Buffer annuities also put a cap on your gains by capping your upside at an agreed-upon rate. So, if the cap rate is 10% and the market goes up 15%, you would receive only a 10% return on that investment for the year. If the market goes up 3%, you would get the full return because 3% is still below the cap rate for that year.

Other types of annuities can help address the rising cost of living and provide the necessary guaranteed income to help support a long retirement. This is done through increasing income options (offered through a rider that may incur an additional cost) that can protect people’s purchasing power and help ensure they don’t run out of money in retirement. Cost of living adjustments (COLA) and enhancing your income payment based on the returns of an equity index such as the S&P 500 are two methods typically used. While each approach has pros and cons, what really matters is the particular need of the investor and how the specific solution will work in concert with other assets in the retirement income strategy.

For a younger investor, it may be important to have some equity exposure in order to take advantage of potential market growth over time. If you’re not invested in equities, you may be missing out on that long-term opportunity for compounded growth that is so important to help assets reach the level they’ll need to help support a long retirement.

To illustrate this point, let’s look at two examples.

For long-term investors, professional guidance is typically to remain invested even when stocks are down. If you had invested $10,000 in the S&P 500® Index at the beginning of 1999, it would have grown to nearly $30,000 by the end of 2018, provided you hadn’t touched it. In contrast, missing out on the 10 best-performing days during that 20-year period would have cut your returns in half.

Next, consider a scenario where John and Mary both invest $100 a month at a 5% annual compound rate of return. John begins investing at age 25, putting away $100 every month until age 65 and Mary begins saving $100 per month at age 35. An extra 10 years of saving means that John has about $162,000 in his bank account, while Mary has only $89,000 by the time she is 65. John’s balance is nearly double Mary’s, and he contributed only $12,000 more of his own money. In the end, time can be one of the greatest tools for building long-term wealth.

Buffered Outcome ETFs: Another innovative solution that investors might consider is investing in exchange-traded funds (ETFs), particularly buffered outcome ETFs. Offered within the highly liquid, transparent ETF wrapper, these new strategies are built to deliver more defined outcomes to investors by utilizing buffers, caps and index-linked returns that can allow people to invest with greater confidence. They provide investors the opportunity to participate in the growth potential of equity markets up to a stated Cap, as well as a limit to downside losses based on a defined Buffer.

Simply put, the larger the market losses, the larger the gains must be to recover. Buffered outcome ETFs may help absorb a portion of those losses and keep them from impacting your retirement nest egg.

The liquidity and flexibility offered by buffered outcome ETFs can be a welcome option in an environment where volatility has become the norm and investors are challenged with a variety of headwinds, including the long-term impact of the pandemic, elevated levels of unemployment, an uncertain political outlook, and the search for yield amid current low interest rates. The ability of buffered outcome ETFs to help smooth out some of the volatility we’ve been experiencing and provide investor portfolios with a level of risk mitigation could make them particularly valuable right now.

A solid risk management plan is more important now than ever. But as you look to manage risk in your portfolio, be sure to consider strategies that can provide the flexibility to address multiple goals. Remember, you are the captain of your ship on the journey to and through retirement. With that in mind, there’s a saying that all investors should consider: “Don’t fix a ship in a hurricane.” Although the initial storm caused by the pandemic is behind us, no one can predict what type of volatility lies ahead. It’s always best to prepare for the unexpected when you can, which may make now a good time to reevaluate your portfolio and consider some of these new, innovative solutions.

About the author: Corey Walther

Corey Walther is the President at Allianz Life Financial Services, LLC. He is responsible for the business results, strategic direction, sales execution and distribution for several Allianz Life Insurance Company (Allianz Life®) product lines into multiple distribution channels.

Annuity guarantees are backed by the financial strength and claims-paying ability of the issuing insurance company.

Diversification does not ensure a profit or protection against a loss.