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Investing With Protection Part II: Reach For Double Digit Investment Returns While Protecting Your Principal.

By Roccy M. DeFrancesco, JD, CWPP™, CAPP™ - Email Editor

Date : July 18, 2006

If you read last week's newsletter, then you know that it is my opinion that while we know the stock market overall should go up over time, we (clients and their investment advisors) do not really know which individual stocks or mutual funds will perform well.

For example, we all agreed that we and our financial advisors would have purchased Wal-Mart over K-Mart in July of 2003. Wal-Mart was, and still is, one of largest companies in the world, is a consistent earner, and pays dividends. Rather than K-Mart, who was just emerging from bankruptcy, had a big marketing tie to Martha Stewart (who was looking at jail time), and no anticipated dividends. How would we have done? Wal-Mart went from $56.08 to $51.76, and K-Mart went from $24.20 to $76.80.

The Three Legs.
During the biggest bull-run this country has ever seen, the average investor did less than 2.5%, when the average mutual fund returned just under 10%, and the S&P 500 returned over 12%. Why? Because we are professionals at buying high and selling low.

Therefore we suggest that many clients allocate dollars towards a concept called The "Maximizer." That is Part II of this two part series.

The Maximizer
The Maximizer is not a difficult concept to grasp. Clients use two investment vehicles: 1) equity indexed annuities (EIAs), and 2) call spread options on the S&P 500.

The stability of the concept comes from the EIA, which has 100% principal protection in a vehicle that also locks in the gains every year.

EIA's provide principal protection; so no matter what the measuring index returns (usually the S&P 500), the investment will never go backwards. The client participates in upside growth of the S&P 500, but there is a "cap" on that growth.

For our examples, let's just assume the cap is 7.5%. Therefore, if the S&P 500 returns 10% in one year, the client's return in the EIA is 7.5%. If the S&P 500 goes negative in a year with its return, the EIA does not lose money. This is stable and safe, but will cap a client's growth if the S&P 500 does well.

The upside in the topic comes from "options," which are purchased on the underlying investment index (typically the S&P 500). Options are not the easiest investment to understand, so let's use an example.

Assume a client buys a $100,000 option on the S&P 500 index. Assume the cost of that option is 10% and that the client has the "option" to sell it at a strike price at 10% above and 10% below the purchase price. Further, assume that the client will realize an investment gain of approximately 85% of the growth of the index up to that strike price which is 10% higher than where it started.

Assume the index is at 1000 when the client purchases the options. On December 31st, the options are valued. If on that date the S&P 500 value is 1100, that would mean that the index increased 10%. Therefore, the gain on the option is approximately $8,500. The client is returned the option cost of $10,000 plus the gain of $8,500.

What if the S&P 500 goes down? If the S&P 500 goes down more than 10%, the entire cost of the option is lost. That's why options are considered a risky investment.

Getting back to how the Maximizer works─the client invests approximately 90% of money allocated to the plan in a principally guaranteed EIA. The client allocates 10% to purchasing options on the S&P 500. Let's look at an example.

Examples: Assume a $100,000 portfolio, risk 10% in options, and an EIA with a 7.5% cap.

What if the S&P 500 goes up 5%?

What if the S&P 500 goes up 10%?

Annuity Grows 5.00% or	$4,500	Annuity Grows 7.50% or	$6,750
Option Grows 4.00% or	4,000	Option Grows 8.0% or	8,000
Total Return	8,500	Total Return	14,750
Percent Return	8.50%	Percent Return	14.75%

In the previous examples, the S&P 500 went up, and the Maximizer returns were significantly higher than what the S&P actually returned ( with 90% of the money protected in the EIA ).

What if the S&P 500 went up 20%?

What if the S&P 500 goes down 5%?

Annuity Grows 7.50% or	$6,750	Annuity Stays Flat or	$0
Option Grows 8.00% or	8,000	Option Loses 6.0% or	-6000
Total Return	14,450	Total Return	-6000
Percent Return	14.75%	Percent Return	-6.00%

15% Crossover Point
Where is the crossover point with the Maximizer where the returns in the stock market will out perform the returns of the Maximizer? The answer is slightly higher than 15%. Therefore, your money manager would have to return 15% on average every year to meet the returns of the Maximizer. Even if your money manager can do so, it will NOT be done while principally protecting 90% of your assets each year.

This topic is tough to explain in a short newsletter. If you would like to a get a real grip on this concept, Trustmakers has a 23-page education module for the Maximizer. The normal price is $54.00, but you can buy the Maximizer module delivered immediately for $26.95 by clicking here .

Summary
How have you done with your investments over the last 5, 10, 15 years? If you would like to use a topic that can principally protect your money (90%) each year and give you upside growth where you can nearly double the returns of the S&P 500 each year, you should look into using the Maximizer. This concept can also be used with money in an IRA or 401(k) plan.

Roccy DeFrancesco, JD, CWPP™, CAPP™

 

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