What is a Guarantee Worth?

What is a guarantee worth?

For as long as I have been in the business, using the word guarantee meant one of two things:

[1] The investment police were going to come through the ceiling tiles, because no investment is guaranteed.

or

[2] You were selling expensive insurance.

Sure there are ways to guarantee or insure your investment portfolio. You could use an annuity with a living benefit [please don't accuse me of promoting annuities; I don't sell annuities, this is just an example].

You could use options[1] to protect your portfolio.

You could use a stop loss[2] that follows the market up. I’m sure there are other ways, but they all have at least two things in common:

One, they will cost you, and two, most financial advisors view that cost as far too expensive.

But what is a guarantee worth?

What is your home owner’s insurance worth if you knew your house was going to burn down once every 5 years?

We know that the market is going to get killed on a fairly regular, but totally unpredictable, basis. We know that the cost of getting killed is huge. We know that it takes a long time to dig out from being killed. We also know that if we could avoid being killed, it would be a huge benefit to us financially, not to mention emotionally.

What we don’t know is if the benefit would outweigh the cost…

Annuities and living benefits have a particularly bad reputation[3], and it might be well deserved, but try telling that to the client-to-be that I met with the other day that has a guaranteed benefit, base valued about the same place as it was at the market high. What about another lady I know that would be living in her son’s basement if she had followed my advice to asset allocate and buy and hold. Instead, she bought a annuity with a living benefit, takes home the income she needs, and has a guarantee [only as good as the insurance company][4] that she will have the income she needs for life, even after the market fell.

I also know people that have made a habit of buying put options every year to protect their portfolios. Their portfolios are worth close to what they were at the market top, and they didn’t lose ten years of their lives from the stress. Try telling them that it was too expensive…

So again, I ask, what is a guarantee worth?

Sources:

[1] Options Strategies: Protective Put, The Options Industrial Council

[2] Stop price, Wikipedia

[3] Long Derided, This Investment Now Looks Wise, Wall Street Journal

[4] Insurers Are Retooling Annuities, Wall Street Journal

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