In the decades since the end of the Great Depression, investment markets were predictable and steady. But, January 1995 introduced a new era of extreme volatility from which, twenty years later, we have yet to emerge. What started as pleasing gains quickly accelerated to euphoric growth that seemingly was without end. It’s what Yale University professor of economics and future Nobel Laureate Robert Shiller called “Irrational Exuberance.”
Then the “Dot-Com Bubble” burst and markets crashed. Three years later, a five-year long recovery began. It ended in October 2007 with the second catastrophic market crash of the new millennium, giving us the “Great Recession.” The crash lasted just 16 months, but six years later, we had yet to recover.
Now we are in another period of irrational exuberant growth with no apparent end in sight. Of course, those who forget history are doomed to repeat it.
The consequences of another “great recession” are very different if you’re a 20-something, a 40-something or a 60-something. Age has everything to do with it because the short-term consequences of another crash are mitigated by the long-term benefits of time. In other words, urgency is directly related to age. The older a person, the more crucial such protection becomes.
It’s what everyone wants: Growth, Safety, and Liquidity. Unfortunately, you cannot have all three wrapped into one. It’s possible to have two of those as long as you’re willing to trade off the third. Good financial planning is about first recognizing this simple reality, then making balanced and realistic choices to meet specific objectives. Ignoring the reality that you cannot have it all is not just naïve, it’s an invitation for disaster.
That this country – or the world for that matter – will undergo another market correction and another recession is not a matter of “if” but a matter of “when.” What we don’t know is what will cause it, when it will occur, how long it will last and how bad it will be. Those are unpredictable variables because they will be based on future events – and human reaction to those events, which are essentially random. The clear implication from this is that anyone who is closer to retirement than the start of their working career need give serious consideration to a shift in their financial thinking. Especially in light of the current economic climate of extreme market volatility and unpredictability, the Irrational Exuberance of unbounded growth is a young person’s game.
To guard against the detrimental effects of the next recession, it’s essential to change the thinking of growth with accepted risk to growth without risk. In other words, embrace the growth with safety pairing, and be willing to trade off some short-term liquidity to achieve it.
The financial services world consists of three industries: Banking, Securities and Insurance. Each of these industries specializes in a different pairing of the three ideals: growth, safety and liquidity. For example, banking instruments (e.g., Money Markets) specialize in safety (yes, banks are safe) and liquidity (ATM Machines). In exchange for that, there is an accepted trade off of high growth potential. Securities (stock market investments) specialize in growth potential and liquidity at the expense of complete safety. This of course is what most people have when younger but with no safety, there is serious risk of loss the next time the market crashes. This is what people with shorter time horizons must avoid. Third is the Insurance Industry that specializes in growth and safety. Those financial products are called Fixed Index Annuities (FIAs). It’s the only way to actually recession-proof a financial portfolio.
FIAs offer recession-protection in two different ways:
They provide the best known pairing of growth potential with complete safety and while some liquidity trade-off must be accepted, the FIAs of today are far more flexible than previously.
They have the ability to create permanent lifelong income. Nobel Laureate economist at Harvard and MIT, Robert Merton admonished that retirees need a promise of income they can count on not unsecured expectation of future accumulation.
Anyone who is concerned about the consequences of the next recession and requires safety without sacrificing growth will find the answer in FIAs, and nowhere else.