Stern Advice: Wary savers get mixed signals from advisers
WASHINGTON Nov 16 (Reuters) - Anxious investors have been dumping their fears on financial advisers in what might be unprecedented numbers.
"They are absolutely petrified," says Diane Pearson, a money manager with Legend Financial Advisers in Pittsburgh. Declining 401(k) balances and abrupt market sell-offs have people going to advisers and asking for security, safety and guarantees.
The problem with that is this: Guarantees are not free, and when you tell an investment professional that you want one, the answer you get will depend on that adviser's business model and world view. Different advisers have very different ideas of how to manage those fears (and, more importantly, the risks that are prompting them).
The price you pay for those guarantees will vary, too.
It's a little bit like when the breast cancer patient is told by one doctor that she needs a lumpectomy and chemotherapy, and by another that she needs radical mastectomy and radiation. She has to decide which answer she likes better and choose her doctor accordingly, even though she's never been to medical school.
The "patient" -- in this case the investor -- has to decide which financial adviser's answer she likes better, though she may not feel qualified to make those decisions.
Here are some of the answers you might receive if you go running scared to a financial pro now.
-- You need an annuity. These insurance products have been flying off the shelves; if you confess your fears to a person who is paid to sell annuities, don't be surprised if you get sold one.
"This year is truly poised to be a historic one for the industry," said Cathy Weatherford, president of the Insured Retirement Institute, an annuity trade group. Sales are up for variable annuities, often used pre-retirement for investing, as well as for fixed annuities, typically used by retirees for monthly income.
These and other insurance products appeal to worried savers and investors who like their guarantees: An annuity typically promises a minimal monthly payment or long-term rate of return. But they all carry fees, some of which are very high. And the guaranteed payouts of income annuities are currently near record lows, because they are predicated on interest rates which are also near record lows. "We are fee-only," says Pearson. "We don't sell annuities."
-- You need to trade more and hedge more. "This is a pretty active time and an ever-changing time," said Richard Brown, a Minneapolis money manager with JNBA Financial Advisers, and also a fee-only adviser. "Anyone who just sat with their head down in pure asset allocation lost their shorts."
Brown has used more frequent trading, short-sold some investments (borrowing securities you don't actually own to sell them) to offset others that his clients owned, and put more of his clients' money into commodity funds.
The downside? More trading means more trading costs, and more bets could minimize losses during market routs, but they could also go against you. Too much hedging and you're giving away the upside.
-- You need options. More than 4 billion options contracts have been traded in 2011, the first time that's happened in a single year, and double the volume recorded five years ago, according to the Options Clearing Corporation. Both E*Trade and TD Ameritrade have recently bolstered their options tools for independent advisers and their clients.
"We're seeing advisers selling covered calls more than they have in the past," said Jeff Chiapetta of TD Ameritrade. In frightening times, investors may be encouraged to sell covered calls -- the right to buy stocks they already own. That doesn't protect them from losing money on the stock, but it puts more cash in their pockets from the options contract sale to buffer that loss.
The downside? There is a trading cost to buying and selling options, and if the price rises past the option strike price on your underlying investment, your shares will get called away, so you'll sacrifice at least some of the upside.
-- You need more bonds. "The safer you want to be, the more I put in short-term, high-quality, fixed-income," says Christopher Van Slyke, a fee-only planner in Austin, Texas.
Among fee-only financial advisers, this is a common response. If you hold an individual bond to maturity, you'll get your principle back and whatever interest the bond is paying. Short-term bonds are less risky than stocks or long bonds, but their returns are low, too. Short-term government bond funds are up 1.92 percent year-to-date through November 10, according to Morningstar.
To bump up returns while minimizing risks, Jonathan Krasney, a Mendham, New Jersey, money manager, has created a conservative income-driven portfolio that consists of 75 percent municipal bonds, "laddered" over 5 years (meaning that their maturities are spread out over that time) with a quarter of the portfolio made up of a variety of high-yield corporate bonds, inflation-proof bond funds, convertible bonds and other higher-yielding bond-like investments.
The downside? Yields are low in safe bonds, and bonds that aren't wholly "safe" do carry default risks. Moreover, if interest rates rise, the value of your bonds (and bond funds) could fall. And even bond-lovers like Krasney believe that bonds are close to the end of their 30-year bull market, because interest rates have no place to go but up.
-- You need a pep talk. Many advisers feel that scary times don't call for different investing strategies, just for more hand holding. If you have a diversified mix of investments that fits your long-term investment objectives, you stick with it and avoid worrying about short-term volatility or arcane strategies, goes this view.
"There's always risk," says Van Slyke, "If you want to do more than keep up with inflation, you have to take risks. And you have to be patient."
(The Personal Finance column appears weekly and at additional times when warranted. Linda Stern can be reached at linda.stern(at)thomsonreuters.com)