When we have a market correction – and we will have one sooner or later – many investors will run to banks and place their assets in money market accounts or certificates of deposit. While those are traditional safe havens for many people, they tend to only be temporary. Once the markets start rising again, investors leave their safe havens to take on more risk.
We need to rethink why we do those transactions and if it’s worth the effort to complete the run to safety. Instead, why not think about proper allocation for a risk tolerance that probably can’t stomach the full amount risk that’s being taken.
As the old saying goes …
You never know how much risk to take until you take too much.
Rethinking Risk Strategies
A temporary shift in risk management does very little for clients in the long run. There are several reasons, but here are three.
Money markets and CDs earn historically low interest rates compared to instruments like annuities. Today, the average annuity is earning 200 to 250 bps more for A-rated carriers on a five-year product. Now, liquidity is not equal as bank accounts are generally liquid while CDs have some type of penalty if not held to maturity. Annuities provide liquidity in emergencies and limited free withdrawals. Remember, we are talking about rethinking allocations to avoid the temporary run toward safety. In a new allocation strategy, liquidity would likely come from other assets first.
Taxation favors annuities. Even during the high tax rates and high inflation/return periods of the late ’70s and early ’80s, tax-deferred assets outperformed their taxable counterparts. Not only in return, but mainly in real return – after tax, inflation and fees.
There is a common misconception that money market accounts can’t lose money. In fact, they do fluctuate in value and can go below their targeted one dollar valuation. With many annuities, the client receives a guarantee of principal plus a minimum interest rate return.
So, safety can come in many forms. The most popular are bank instruments, which serve a great purpose. However, the numbers point toward a better solution: better nominal and real rates of return, lower tax rates, and more stable values. Add in the fact that charges are not paid upfront and only when you do not hold the asset to maturity. This makes the purchase efficient from a cost perspective, an effective way to increase yields on conservative vehicles, and provide confidence to the client by showing them a more stable valuation of their conservative asset selection.
Don’t follow the leader or the crowd when the market corrects. Rethink your current allocation strategies and look at the real returns to help clients protect their wealth the most efficient way possible.
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