Investors who are retired or nearing retirement are in a tough position. They need growth in their stock market portfolios to combat inflation and rising health care costs, but if the market falls significantly again, stocks could enter a “lost period” where they don’t have time to wait.
As a general rule in today’s investing era, many financial companies tell recently retired people to keep at least half their portfolio in stocks and reduce that percentage as they get older. In the past, someone who was 65 years old and owned 50% of the stock would have been considered active. But with the U.S. stock market becoming record-highly concentrated in a small number of big tech stocks (about a third of the S&P 500), concerns about an AI bubble and a major market correction are warranted.
Semiconductor sales accounted for about 92% of GDP growth in the first half of this year, and without chip sales, the U.S. economy would have grown 0.1%, according to research by Jason Furman, a Harvard economist and former adviser to President Obama. Federal Reserve Chairman Jerome Powell said Wednesday at the latest FOMC meeting that AI is a major source of growth for the U.S. economy, unlike the dot-com bubble. While that may be a good thing in the long term, it could also lead to incremental risks for investors in the short term if the return on investment from AI is not realized soon.
Given the recent success of the U.S. stock market, retirement investors are looking for ways to reduce their stock exposure and stay invested without taking on as much stock risk, while still expecting strong returns for their portfolios. More retirees are putting money into ETFs that generate equity returns, creating what fund managers in the space say will help them move forward more smoothly.
Buffered ETFs, also known as defined outcome ETFs, use options to protect against a certain level of loss while locking in some of the upside. For investors who have always relied on bonds and Treasury bills to cushion stock market downturns and generate income, they have grown exponentially since the pandemic.
“It’s been incredible,” Mike Lucas, CEO of the TrueShares ETF, told CNBC’s “ETF Edge.”
The buffering ETF category has returned about 11% annually over five years, according to an April Morningstar report. Assets in this category have swelled to more than $30 billion, with billions of dollars of new inflows each year.
“A lot of wealth is moving from the accumulation phase to the distribution phase. Many of these investors today still need growth, but they need growth with risk protection and clear outcome room,” Lucas said.
This also means a major shift in investor mindset, with fewer investors focusing on catching up with or outperforming the S&P 500. Lucas says retirees are now looking for what he calls “good performance,” or stable, predictable returns commensurate with peace of mind.
But in addition to the lag in strong bull markets as a result of that structure, there is also another trade-off: higher costs. Buffered ETFs typically have annual fees of about 0.75% to 0.85%, while common stock index ETFs like Vanguard’s VOO or SPDR S&P 500 SPY have annual fees of 0.03%. But for retirees who value capital preservation, diversification, and peace of mind, the additional cost may be worth it.
“These are inherently math-based products,” Lucas said. “They usually deliver on expectations.”
Largest buffered stock ETF
FT Best Ladder Deep Buffer ETF (BUFR): $7.9 billion in assets/0.95% net expense ratio Innovators Defined Wealth Shield ETF (BALT): $1.9 billion in assets/0.69% net expense ratioFT Best Ladder Deep Buffer ETF (BUFD): $1.5 billion in assets/0.95% net expense ratio Innovator Equity Managed Floor ETF (SFLR): $1.2 billion/net expense ratio 0.89%
Source: ETFAction.com
