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Welcome to How to Retire on Time, a show that answers your retirement questions. Say goodbye to the oversimplified advice you've heard hundreds of times. This show is about getting into the nitty-gritty so you can make better decisions as you prepare for retirement. Text your questions to 913-363-1234 and we'll feature them on the show. Don't forget to grab a copy of the book, How to Retire on Time, or check out our resources by going to www.retireontime.com.
Welcome to How to Retire On Time, a show that answers your retirement questions. We're here to move past that oversimplified advice you've heard hundreds of times. Instead, we want to dive into the nitty gritty because, well, frankly, there there's no such thing as a perfect investment product or strategy. There are certain things you just need to know, so we wanna dive into that. As always, text your questions to (913) 363-1234.
Mike:And remember, this is not financial advice. This is just a show, so do your research. David, what do we got today?
David:Hey, Mike. Aren't buffered ETFs and indexed annuities basically the same thing?
Mike:Yeah. Okay. Next question. No. Let's break it down, though.
Mike:There's some interesting components to this that you need to understand. So first off, yes, they're kind of the same thing. There's two ways these are gonna operate. I'm gonna get a little technical, but you need to understand this. Okay?
Mike:Basically, they're built around option contracts and the bond market. So a buffered ETF really is going to sell option contracts to where let's use an example. Let's say you get up to 7% growth, but no downside risk. This is a hypothetical example. These offers change often.
Mike:Okay?
David:So the buffered ETF offers 7% upside.
Mike:Yeah. So if if the S and P goes up 7% or more, your cap is 7%. Uh-huh. What they've really done is they've sold the potential profits of everything above 7% to someone else. They've sold that.
Mike:They made money on that. Then they turn around and they buy protection to say if the markets crash, someone else has taken the hit. Now you might think, well, I can do that on my own. No. You can't.
Mike:Because you need many multiple tens of millions of dollars at least to get the reasonable priced contracts. On your own, maybe you can do like a four four, 5% kind of situation. Maybe. Even that. And that's still pushing it.
Mike:Because retail investors don't have the quantity or the volume to get the better deal.
David:So you pool your money with other retail investors and and
Mike:Yeah. Yeah. That's that's why it's better to do an actual buffered ETF, if that's what you want. Now the benefits of a buffered ETF, yeah, it just rolls over every year, which is kinda nice. So you can utilize them with long term capital gains.
Mike:You get up to 7% in this example. No downside risk. Or maybe it's like the market has to crash more than 60% for you to start losing money. So if the markets go down 55%, you didn't lose anything for that year, twelve month period of time. If the markets go down 65%, you just lost 5%.
Mike:That's that's a pretty good deal, all things considered, when it comes to protection. But you're capped at this 7% growth. Now the other way that this is done is where whether it's a buffered ETF or a bank or an insurance company, they could buy bonds or notes. So a a fixed amount for a certain period of time, fixed interest rate. So let's say you get a $100,000.
Mike:This is kind of tactical, but hopefully you can follow me on this. Let's say you've got $100,000, and you put 95,000 of it into a note that's gonna give you 5.2%. Okay. After twelve months, that note will then become 95,000 will become a 100,000. So the principal is protected.
Mike:You see how that works? Yep. 95,000 becomes a 100,000 in one year at that rate. Okay. So then they'll take the rest at $5,000, and they'll buy option contracts for the right to buy.
Mike:If the markets go up, they'll exercise it. Everyone makes money. Mhmm. K? The problem, though, and people miss this, is if interest rates go down, if the ten year treasury goes down, these instruments aren't gonna get that 5.2% rate.
Mike:They might get a 1% rate. They get a 1% rate. Maybe they end up getting, like, $500 left that they can use to buy option contracts. So the upside potential is going to decrease because they're constrained by the financial markets, specifically the bond markets. When you understand how instruments actually work, when you can pop open the hood, like when I open up a car, I can point to an engine.
Mike:I could change the oil, but I can't explain all of the different nuances of it. Mhmm. But we pop open the engine of a financial instrument, I can explain every little detail to it. When you understand those details, you understand the risks you may or may not be taking with the different routes. So, yeah, generally speaking, they're kind of the same, but when you get into the details, you need to understand the length and the underlying mechanisms that allow these offers to exist.
Mike:Why am I saying that? Fixed index annuities have a couple of variables that people need to understand. These are risks that are not talked about enough in my opinion. So some of them might offer like, let's and I'm being fictitious here. Let's say they offer 10% on the upside of the S and P 500 K.
Mike:But no downside. Now that's better. That's 3% better than a buffered ETF by way of comparison. Well, how can they do that? A fixed index annuity is illiquid for a certain period of time.
Mike:Yeah. So they're buying the instruments under different time frames because they know you're probably not gonna pull your money out, and if you do, you're penalized for Yeah. There's a reason why the penalty is there. There's a reason why they're structured as such, because they need the money to stay there to buy certain contracts to structure the product appropriately.
David:They incentivize you to not pull it up by having that penalty.
Mike:Yeah. Yeah. So if you want better rates, you'll need to give up liquidity. You can't have your cake and eat it too. So some people might buy some buffered ETFs.
Mike:Some people might buy some index annuities because they want a slightly better rate, and they know they don't need all of their money next year, but they might need some of it later on. They're looking for protection with a little bit better growth potential. But then here's the kicker. Depending on the product, if you really dive deep, some of them will only buy the contracts year over year, and so maybe in three years of the contract, they'll significantly drop rates because they can't maintain that rate. They over promised.
Mike:The Fed dropped rates. The ten year treasury is lower, and so now they they don't have the room to just do this. So you now went from that 10% cap, it's like a 3% cap.
David:This is the insurance company we're
Mike:talking This is an index annuity now.
David:Okay.
Mike:So all the people listening in that are pissed
David:Yeah. When you
Mike:look at your statements, I can only get 3% growth, That's why. The product you bought, there was not enough due diligence to understand how the product was actually functioning. And then when interest rates changed, you you got your legs cut out from underneath you. It's still illiquid, and you're getting less upside potential.
David:Is this why it feels like insurance companies are always trying to like, you know, quote unquote rip us off?
Mike:It's just they're not being explained well.
David:Okay.
Mike:K? It's like medicine. Hey, this is gonna do a benefit for you. Don't ask me any other questions. Modern medicine is a miracle.
Mike:Mhmm. Modern medicine has side effects. Mhmm. You need to understand the side effects and weigh if you're willing to go with it or not. It's that simple.
Mike:So there are index annuities that will offer you more stability or more predictability. Like, let's say instead of the 10% growth, maybe you get like a six and a half. If the markets are up, you're gonna get six and a half, seven and half percent guaranteed for the life of the contract. Markets are up, that's your return. Markets are down, you don't get a return, but you don't lose money.
Mike:You can have locked rates, but a locked rate is gonna be less than the potential rate. So you have to understand and sit on these things and really ask questions or work with someone that's so blatantly honest like we're being right now about how they work and what realistic expectations are, so that you can buy the right products based on your lifestyle and legacy goals, and also kind of just maneuver everything in a way that it fits your objectives. Put the plan together first, then explore the efficiencies, such tax efficiencies and so on, then find the right products. And there's always a benefit, and there's always a detriment, and what's right for you is gonna be different than what's right for someone else. It may be buffered ETFs.
Mike:It may be indexed annuities. If you want a death benefit, maybe it's indexed universal life insurance. Just remember, though, you don't buy that unless you need the death benefit. You can't manipulate Wall Street. You can't manipulate the markets.
Mike:They are. And the second you think you're getting a deal, you're the one that's getting taken advantage of.
David:Yeah. So a little humility is in order then maybe.
Mike:Humility or stopping and asking the question, what don't I know that if I knew would change my decision? If you're ever pressured in, like, right now, interest rates are going down, which means the offerings are going down. Because the Fed's lowering rates and started that, maybe the ten year treasury will start lowering as well. We don't know That's an independent thing, but they kind of rhyme together. If that goes down, then CDs, treasuries, fixed annuities, fixed index annuities, index universal life insurance structure notes, buffer ETFs, all of these things that offer protection with growth potential will become less competitive because they're tied to the bond market.
Mike:What you don't do is you don't panic and say, oh my gosh. I don't wanna miss out on the opportunity. Let me just buy it right now. It's better to know, in my opinion, what you're getting into than to do a panic buy and risk the regret.
David:So
Mike:be mindful of it, but they are very similar buffered ETFs and fixed index annuities, but they have their differences, and their differences matter. 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 podcast. Just search for how to retire on time. Discover if your portfolio is built to weather flat market cycles if you're missing tax minimization opportunities that you may not even know exist.
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