More retirement investors are choosing a “good enough” equity portfolio strategy to protect their market money
Retirees and pre-retirement investors are in a tough spot. They need their stock portfolio to grow to fight inflation and rising health care costs, but another big market decline could leave stocks in a “lost period” they don’t have time to wait for.
In today’s investment era, the general rule of thumb is that many financial firms tell recent retirees to keep more than half of their portfolio in stocks, and to taper off as they get older. Once upon a time, a 65-year-old man with 50% of the stock would be considered aggressive. But with the U.S. stock market’s record concentration in a handful of big tech stocks — about a third S&P 500 — fears of an AI bubble and a major market correction are justified.
According to research by Harvard economist Jason Furman, a former Obama White House adviser, chip sales accounted for roughly 92% of GDP growth in the first half of the year, and without chip sales, the US economy would have grown by 0.1%. Federal Reserve Chairman Jerome Powell said at the last FOMC meeting on Wednesday that artificial intelligence is a major source of growth for the US economy, unlike the dotcom bubble. While this could be a good thing in the long term, it could also increase risk for investors in the short term if the return on investment from AI doesn’t materialize quickly.
The recent success of the U.S. stock market has retired investors sitting on big portfolio gains, but they’re looking for ways to reduce their exposure to stocks and stay invested without taking on too much equity risk. More and more retirees are putting their money into capital income-generating ETFs to create what fund managers in the space say will be a smoother path forward.
Buffer ETFs, also called defined-outcome ETFs, use options to protect against a set level of losses while still capturing some of the growth. They have grown exponentially since the pandemic as another way for investors who have always used bonds and short-term Treasuries to cushion stock market declines and generate income.
“It’s rocketing,” Mike Loukas, CEO of TrueShares ETF, said on CNBC’s “ETF Edge.”
According to a Morningstar report in April, the buffered ETF category has returned 11% annually over five years. Assets in this category have grown to more than $30 billion, with billions added each year.
“A lot of wealth is moving from the accumulation phase to the distribution phase. Now, a lot of these investors still need to grow, but they need to grow with risk protection and a defined headroom for results,” Loukas said.
It also means there’s been a big shift in investor thinking, with fewer investors focused on maintaining or beating the S&P 500. Now, according to Loukas, retirees are targeting what he called “good enough performance” — steady, predictable returns that match their comfort level.
But in addition to falling short of strong bull markets due to their structure, there is another trade-off: higher costs. Buffered ETFs typically charge annual fees of around 0.75% to 0.85%, compared to 0.03% for a simple stock index ETF like Vanguard’s VOO or SPDR S&P 500 SPY. But for retirees focused on capital preservation, diversification and peace of mind, the extra cost can pay off.
“They’re essentially mathematical products,” Loukas said. “They usually deliver what they have.
The largest buffered equity ETF
- FT Vest Laddered Buffer ETF (BUFR): $7.9 billion in assets/0.95% net expense ratio
- Innovator Defined Wealth Shield ETF (BALT): $1.9 billion in assets/0.69% net expense ratio
- FT Vest Laddered Deep Buffer ETF (BUFD): $1.5 billion assets/0.95% net expense ratio
- Innovator Equity Managed Floor ETF (SFLR): $1.2 billion net expense ratio/0.89%
Source: ETFAction.com