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Welcome to How to Retire on Time, a show that answers your questions about all things retirement, including income, taxes, Social Security, healthcare, and more. This show is an extension of the book How to Retire on Time, which you can grab today on Amazon or by going to www.howtoretireontime.com.
This show is intended for those within 10 years of their target retirement date or for those are are currently retired and are concerned about their ability to stay retired.
Welcome to How to Retire On Time, a show that answers your retirement questions. We're here to move past that oversimplified advice and dive into the nitty gritty. Now remember, this is just a show. It's not financial advice, so please do your due diligence. You got questions?
Mike:Text them to (913) 363-1234, and we can feature them on the show. David, what do we got today?
David:Hey, Mike. Can you explain buffered ETFs and which you'd use in different situations?
Mike:K. So a buffered ETF, by definition, it's not an ETF like you would think. So an ETF is this, you buy one thing, so one ticker, one symbol.
David:Okay.
Mike:And in there, it gets you access to all sorts of, like, stocks. Like, you'd think of an ETF as index funds. That's what's commonly what it's used as.
David:Is it anything like a mutual fund? They're just built differently.
Mike:Lot of similarities. ETFs are kind of the new way that things are going. So an exchange traded fund, you can trade it in the middle of the day. Mutual fund, have wait until the end of the day sell.
David:Good distinction. Alright.
Mike:Yeah. An exchange traded fund, that's really what it is. They were made popular, I believe, by Vanguard. Actually, I'm guessing. But I mean, Vanguard, Fidelity, BlackRock, State Street, everyone uses them.
Mike:And it's it makes life really easy. K? So instead of you buying all 500 stocks of the S and P 500, it's not actually 500. The number varies a little bit.
David:Okay.
Mike:Or the 100 stocks of the Nasdaq, and you have to have a lot of money to do that because some of the stocks each stock position's, like, very expensive and some are cheaper. That complicates things. You wanna buy the total market. Buy one of every stock. That's a tough thing to do.
Mike:And then to balance it and to manage it. So people like buying ETFs, exchange traded funds, because you can buy one ticker, and it gets you the appropriate exposure and balance and all that of all the different positions. It it makes things easy. That's an easy way to diversify your assets. That's why you hear about it.
Mike:A buffered ETF is not at all what that is. Oh. It's still within the exchange traded wrapper. There were some laws that were adjusted or updated that allowed for buffered ETFs to exist. So what is a buffered ETF?
David:Yeah.
Mike:It's a very complicated thing. I'm gonna simplify really quick.
David:Okay. Steal it down for us.
Mike:And if you really wanna understand, by the way, how these things work, ChatGPT, Grok, Cloud, whatever your favorite AI is. Mhmm. One that you can chat and you get back and forth on. They can be a very effective tool to get objective explanations on how things work. Mhmm.
Mike:Because they don't care what you do.
David:Right. Right.
Mike:Yeah. Their job is to present the facts. So you can go home and say, hey, AI, how does a buffered ETF work? What are different types of buffered ETFs and so on? And they will give you objective advice without the sales pressure.
David:So you've done this, and you feel like the information you've gotten back is is legit?
Mike:When you're looking for definitions, it's good. When you're looking for advice, it's terrible. Don't do
David:it. Okay. Alright.
Mike:And the reason why is the advice is based on whatever's most popular, and whatever's most popular may not be what's right for you. So it's good, but you need to get to the nitty gritty of your specific situation. The emotional side, the financial side, the lifestyle side, the legacy side. There's just a lot of questions before you start giving a solution, and AI is trained to give you a solution based on the limited information you've given it. And and no one's gonna write a dissertation into AI saying, here's everything I want.
Mike:It's like five pages, and then it pumps out a response. Like, that's not really how people use it. And even then, it probably wouldn't give that good of a response because it's too much. So I digress.
David:Yeah. Buffered ETFs. Yeah. Please.
Mike:So a buffered ETF, the concept is as follows. They're going to they're not actually buying the market. They're synthetically buying contracts that will give someone the right to basically have the growth if the growth is there. Uh-huh. Okay?
Mike:So synthetic is a keyword here. They're not just sitting there buying it and saying, well, you know, if it works out, it works out. Like, there's a lot of contracts, either options that make these things possible. The simple explanation I've got is imagine if you bought into the S and P 500. K?
Mike:Usually, they do the S and P 500 for these. You bought into it, and you've sold a contract. So you've sold away the gains above, let's say, 7%. So you get the first 7%, but you've sold away the gains. You might say, well, Mike, why would anyone do that?
Mike:Because the sell of those gains, anything above 7% that someone else is gonna make a profit on if the S and P grows at that rate, you then take the money, and then you buy protection.
David:Okay.
Mike:You buy a contract that says if the markets go down, someone else is gonna take the hit. And if you think about it for a second, over the long term, these institutions are okay with that because the market, I think it's 66% of the time, has double digit returns. So the person that's buying the gains above 7%, statistically, will probably make a good amount of money in most situations. And the few times they don't, it's fine. And then the time where the markets go down, every seven to eight years, they might have a hit, but overall, they're making money off this.
Mike:So over the long term, these institutions have a risk rated system on how much protection they're willing to give for a certain price point that the pricing and the market conditions even itself out to where you you've just got a simple situation if you get the first kind of gains, and then other people take care of it. Do you see how that kinda
David:works? Sounds to me, and you tell me if I'm right here, you there's a little bit of a trade off. You're trading potential huge gains for some protection. Yeah. Someone else gets the gain above 7%, let's say, in this example, but in exchange for that, you can know that, hey, well, I won't lose any or my losses will be cut smaller.
David:Is that right?
Mike:Yeah. Mean, each of these contracts, someone's taking on risk for a potential reward, and someone is giving up a potential reward to get rid of a risk. Ah. That's what these contracts are.
David:Okay.
Mike:You can't have your cake and eat it too. So the buffered ETF is a mechanism. It is a tool in the tool belt to have more consistent, potentially consistent returns. You've kind of narrowed your focus, so you might not hit the home runs, but you're hedging against that downside risk. It's kinda like that movie Moneyball.
Mike:Remember that? I do remember that. They just focus on getting on first. Uh-huh. So great movie if you haven't seen it.
Mike:Yes. It's kinda like the Moneyball situation. You just want slightly better growth potential than a CD or a money market would give you, and you're okay every seven or eight years or once in a while you just get a zero, but overall, you should be making more money. That's the idea. K?
David:Okay.
Mike:Now I think the question asks, like, different kinds of buffered ETFs.
David:Yeah. We we've hit the first part of explaining what a buffered ETF is, and the second half of the question, which one would you use in different situations?
Mike:So let's highlight different types of buffered ETFs.
David:Okay.
Mike:One might have, let's say, a 100% or 60% downside protection. K? These are called max buffers. So if the market goes down 55%, you didn't lose anything other than fees. If the market goes down, let's say, 65%, assuming you have that 60% buffer, you lost 5% and then fees.
David:Okay.
Mike:Fees might be, like, I don't know, point 7%. Sure. So when you look at that, would anyone be mad if the markets are down 65% and you were only down 5%? Oh. I mean, really?
Mike:That's not that bad of a situation.
David:You'd be thinking you're lucky stars. Right?
Mike:Yeah. But if the market's up 20% and you only got seven Mhmm. You're kind of upset. Right. So you have to understand that maybe a part of your portfolio is in this group, if at all appropriate.
Mike:Now another version of a buffered ETF might be, and I'm not quoting products here, I'm giving an example of how the benefits versus detriments would work. Mhmm. So maybe you've got a buffered ETF that's got 12% upside, but you're gonna take on the first 5% of losses, And then after that, maybe there's a 20% buffer. So if the markets go down 25%, you lost 5%.
David:Okay.
Mike:Because you've got the first 5% that you're taking on. Right? You with me?
David:Yes.
Mike:If the market's down 30%, k, maybe maybe you lost 10%, not 30%, because you had that 20% buffer.
David:Oh, sure. Okay.
Mike:So you lost five percent on both sides. I mean, they're complicated instruments. Mhmm. Let's just say it as it is. Now everything I've just talked about, these are annual buffered ETFs.
Mike:So you buy it and you hold it for a twelve month period of time. That's when the buffer or the contracts renew. You locked in those gains or the protection, and then it rolls over to the next iteration of the contracts.
David:So does that mean you can't, like, sell it then or you can't get rid of it?
Mike:You can sell it at market price.
David:Oh, okay.
Mike:So, like, let's say the market's up 10%. You've got a max growth of 7%. Who's gonna buy that from you, have no growth potential, and 7% downside risk? And so maybe even though markets are up, you sell it at, like, 4% gain. So someone has still three percent growth, 4% loss, like they're coming in halfway through.
Mike:That's a negotiation. You can't rig the system.
David:Okay.
Mike:And you also you have to operate off of the contract's time. So if it's scheduled for a year and you wanna get out halfway through, someone else has to be willing to buy at a fair price. So what is that fair price? What are you willing to sell it for, and what are they willing to buy it for? When you can kind of take a step back and look at both sides of what would be a fair deal, then you can get a better expectation of what you might be able to sell it for.
David:So is it advisable then though to just stay in it if at all possible?
Mike:Yeah. Yeah. But that's not financial advice.
David:No. Okay.
Mike:Now let's talk about quarterly buffer ETFs.
David:Okay.
Mike:These are a different one. So and by the way, you could increase the upside potential, but you're decreasing the downside risk. Because the more upside potential you have, the less upside potential you're selling to someone. So that means you have less money you're gonna get, which means you've got less money to buy the protection. Okay.
Mike:So it moves in tandem, one side with the other.
David:I get that.
Mike:If you want all the upside, you've got no downside protection. That's called just buying an ETF. There's no buffer there. A quarterly buffered ETF, it's going to be so every quarter. Right?
Mike:But you have smaller growth and different size of protection, but it renews every quarter. So maybe instead of 7% upside growth, you've got in this quarter 3% or 4%. Oh. And that rolls over. So technically, you have 12%, but if all of the growth in a year happened in one quarter, you only got that quarter.
Mike:So it complicates things. Now when would you use any of these things? Like, yes, these are complicated. Yeah. There are some I'm not endorsing any of these companies, but you've got First Trust.
Mike:You've got Kalamos. You've got BlackRock. These big companies, they offer these buffered ETFs. Do your due diligence. Find which one's right for you, if any.
Mike:We're not endorsing or supporting any of them. You could just Google buffered ETFs. It's harder to create a buffered ETF on your own, because these are contracts that require many multiple millions just to even entertain the idea of getting a good deal. So go through on the big companies Mhmm. If you do it.
Mike:When would you do this? There's a couple of plays or strategies that you might consider. So one is if you think we're at the market top, but you don't wanna miss on the upside growth, you might consider, let's say, a quarterly buffered ETF or an annual buffered ETF that has that downside risk. And here's the simple thought process. If the markets are gonna crash, great.
Mike:Wait until the buffer matures, You lock in your protection or the contracts, and then you buy back in a lower rate. I mean, just imagine this is a hypothetical example. Let's say you've got a 20% buffer. It's an annual buffered situation. K?
Mike:And you put some money in there. You still want some growth, but you feel like the markets are gonna turn over, and the markets just tanked. Let's say they a 40% crash during your time within the buffer ETF. So you lost 20%, not 40%, because there was a 20% buffer somewhere in there.
David:Okay.
Mike:That still stings, but you lost 20%, not 40%. You can take the money then, buy back in at its lowest price. And if you're buying back in, don't buy back in at stocks. Not all stocks are gonna go back to the the original price.
David:Alright.
Mike:You wanna buy into, like, indexes because overall, the index hopefully should be able to recover. Yeah. You're buying things at a discount now. Yeah. You lost some money along the way.
Mike:Maybe you did the buffer that's 60%. So if the market's down 40%, you didn't lose anything. You have to wait till the buffer renews, and then you buy everything at a 40% discount.
David:Oh, okay.
Mike:Now that requires the annual bit, so there's a bit of a timing mechanism there that you have to consider. What if you put some of your assets into quarterly buffered ETFs, and then the markets tank, let's say, 20% in that quarter, 20% in the next quarter, well, your buffer took out a lot of the losses. You still had some losses, but not all of the losses, and now you're taking those funds and buying back in. Do you see how it's you accept that we could be at a market top. You accept that things could be overpriced.
Mike:You're still looking for upside growth. But if or when the markets tumble, you've buffered out some of the losses, not all of the losses, but some of the losses Yeah. And you go back and then buy at a discount. This is an interesting idea for a long term strategy of just trying to grow your money.
David:Okay.
Mike:For retirees, it might be a little bit different, because you might say, well, I need protection. So you might do some max buffer, So you get as much of the buffer as you can, much protection as you can. And if the markets go down, okay. Well, you've spread out, so you've got maybe a February buffered ETF. You've got a couple in the June.
Mike:You've got a couple in August or September. So you've got different portions that have the guarantees that renew.
David:Okay.
Mike:And it's not principal protected. It's a buffer. If it's a 100% buffer, again, I'm reiterating myself, a 100% buffer, that's a nice situation. You've got more protection. 60%, you might lose a little bit, but not significant losses.
Mike:Do you see the difference?
David:Sure. Yeah.
Mike:So that if you need income, what do you do? That's your reservoir. That's your protection. That's your moat. Whatever you wanna call it.
Mike:You take income from assets that haven't experienced significant losses so that your other accounts can recover.
David:So you could take income out of this buffered ETF as opposed to maybe your regular Yeah.
Mike:When it matures.
David:Yeah. Okay. When it matures. Right.
Mike:I'm gonna pick on NVIDIA. I'm not saying this is gonna happen to NVIDIA, but let's say NVIDIA does what Cisco had. Okay. So Cisco in 2000 lost like 80% in a year. Uh-huh.
Mike:Let's say NVIDIA I don't think this will happen, but let's say NVIDIA loses 80% in a year. You don't wanna sell Right. When it's 80% down. So maybe you take some out of the buffered ETF and see where it recovers. That's the idea.
David:And so it sounds like maybe when you're a little bit more mature in your investments and you have built up a good nest egg, is this when it's a good time to do buffered ETFs? As opposed to someone in their thirties who's still in the accumulation phase, should they be accumulating with a buffered ETF?
Mike:Yeah. This is a great question. Okay. So in my mind, this is my opinion.
David:Okay.
Mike:I'm not recommending anyone to follow this financial advice.
David:Alright.
Mike:Seek individual advice. Everyone is different. That's how you know there's no sales pitch here.
David:True. Yes. Yes.
Mike:We wanna be consultants. You know, it's like your nutritional plan would be different than someone else's nutritional plan. Everyone's gonna be So I would not be surprised if younger people start putting some assets into quarterly buffer ETFs. And the reason is if we are at a market top, and you look at the Schiller PE ratio, you look at the general PE ratio, you look at just the general sentiment that I mean, when I go to the grocery store line and some high school kid is the check out guy, finds out I work in finances, yeah, we're at a market top, aren't we? It's gonna crash soon.
Mike:If he or she is telling me that Yeah. It's like everyone's waiting for the other two to drop. Uh-huh. So even if younger people were like, oh, yeah. You can write out the ups and downs, but what if you put some money into a buffered ETF so you buffered out some of the losses so you could buy back in more efficiently at the mark that's that's another version of dollar cost averaging.
Mike:Uh-huh. Now you might lose some of the upside potential in the meantime, but I mean, look at the market value in '98 and '99, and then what it was in 02/2002. The question is, when are you selling, and when are you buying, and what are those price points? You can't time the market, but it would be interesting from a strategy standpoint. Then you also got the retirees.
Mike:Yeah. You might wanna lock in some of your gains and start putting some money in protection. Something that has maybe not complete protection, but a hedge against these market crashes. Yeah. Buffered ETFs are a tool to be used when appropriate.
Mike:It's not the only tool. You've also got fixed indexed annuities, which may be less liquid, has some more growth potential, but that's also a tax conversation. That's also a mechanism conversation. When and how would you use it? Sometimes fixed index annuities are not even appropriate at all.
Mike:Sometimes they are appropriate. They just let's define things as they are. But, yeah, buffered ETFs, especially right now, very interesting part potentially of someone's portfolio in the different ways it could be used. That's all the time we've got for the show today. If you enjoyed the show, consider subscribing to it wherever you get your podcasts.
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