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Avoiding Disaster

Earlier this year, the S&P 500 dropped 34% in 1 MONTH, taking everything including index funds down with it. A recovery of sorts is underway, but no one knows how long it will take to get back to the previous highs.


In 2000 and 2008-2009, the S&P suffered even greater hits and it took many YEARS for investors to recover!


The good news is that your broker/advisor can do some things for you which can give you the upside in the S&P, but drastically reduce or eliminate your downside risk...if he's willing to do a little extra work for you! 


Years ago when interest rates were higher, an investor could capture 100% of any annual appreciation in the S&P...and completely avoid any loss if the market declined or even crashed...as demonstrated in the following example.


If the investor wanted to invest, say, $100,000 in the stock market, his broker would take a small amount of that and buy a 1-year CALL OPTION on the S&P 500. The rest of the money, perhaps 90% - 95%, would be invested in a safe, 1 year interest-paying instrument like a T-Bill or CD. The option would guarantee that the investor would realize 100% of any S&P appreciation during the year on $100,000 worth of the S&P, and the interest earned on his "safe" money would recover the initial cost of the option. Result: If the S&P went up, say, 15% during the year, the combined value of the two investments would be worth $115,000, matching the S&P. If the market declined or even crashed, the investor retained his original $100,000, losing nothing!


Obviously, the key feature of this technique was that the earned interest was able to recover the cost of the option. When that wasn't possible...as would be the case today... the broker would SELL a few short term "out of the money" (above the market) S&P call options during the year to raise additional cash. This required no additional investment and could be done as often as necessary, with the broker monitoring the positions as the year progressed.


Most brokers/advisors are trained and licensed to deal in S&P 500 index options as described above, but they may resist. First, it requires them to do a little more work for you during the year. Second, and perhaps more to the point, the commissions using this strategy are minuscule and considerably less than the 1% or so they would typically earn for "managing" a stock portfolio for you. 

 

But it's your money! They're supposed to be working for you!


Remember:


I. The vast majority of stock-picking strategies and funds consistently fail to even match let alone beat the S&P 500.


II. S&P 500 index funds will beat those poor performers, but they too decline and can crash right along with the market...because they are the market.


III. Using the strategy described above, 90-95% of the investor's money is always invested in safe, interest-earning instruments.


IV. The market can crash at any time for any number of reasons. Failing to protect against those events is an invitation to disaster!