In choppy and down markets it’s natural to be nervous … so, it’s no wonder that investors start to look at funds that purport to ‘guarantee’ your initial capital, your return, or some combination of both.
I have a close friend who is a financial adviser, who works strictly on a fee basis, yet his practice is associated with the products of one major insurance and fund management company.
He was telling me of the rise of these Absolute Return funds that work on the basis of not only guaranteeing the original amount that you invested, but also lock in your returns to date …
– in other words, if you invest $1,000 this year and the market falls, the fund guarantees to pay you back at least $1,000
– then next year is a good year for the market and your fund increases by 10%; now the fund guarantees to pay you back at least $1,100
– but, next year there’s another market crash and the market drops by 15%; but, the fund STILL guarantees to pay you back at least $1,100
– if you remain with the fund and the market eventually totally recovers, as soon as the fund value rises above your new $1,100 ‘guarantee’ then so does your return.
There have been plenty of systems that have produced similar results … they usually do this by some combination of insurance and/or derivatives (e.g. stock options). In fact, you could replicate some of these results for yourself simply by buying the right type and duration of stock option along with the underlying stock (or index).
The problem is that all of these end up costing you money: the insurance premium and/or options are bought out of your initial (or ongoing) investments. The ‘cost’ of these ‘guarantees’ comes as some combination of increased fees or reduced returns when compared to a similar fund that does not offer the ‘guarantee’ …. it’s that simple.
You can provide yourself a similar – or better – result at far less cost: buy a low-cost Index Fund and wait 30 years to cash it out; I can virtually ‘guarantee‘ an 8.5% minimum return 🙂