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Actually, if it is so simple, and considering that most people with some disposable income do indeed tend to invest in stocks, how do you explain the fact that most investors have NOT made $3M (or $2.6M in total market fund) from a $100k invested in the 1980s?
If they had the money to lump sum in and let it ride then there is no reason they wouldn’t have . An s&p 500 fund would have been within 400k...it is simple math so I am not sure of the question .
But most people have to dollar cost average in and so they get totally different results.. but even doing nothing with a total market fund or s&p 500 fund would have been in the ballpark and that is just letting it ride with no attention had you invested the same amounts
As of July one the value is 3,038,000...that is not even a great record ,, there are newsletters that did even better but took on more volatility... these fidelity funds were nothing special ...
In fact the fidelity insight sector portfolio blew away the above growth model since then . It started a year later in 1988 and is 4.4 million as of July 1.
I started with them back in 1987 with their growth model for decades . I never used their sector portfolio but boy I sure wish I had . They averaged 12.70 % for over 30 years...the growth model averaged 10.60 for 32 years.. the s&p 500 clocked in at 9.60% over the same time frame ,,a total market fund about 9.70%
what is interesting is In 1995, indexed annuities were first developed and designed to compete head-to-head with Certificates of Deposit (CD) returns, not the stock market.
but unregulated sales forces found an easy way to sell them by promoting them as equity investments with no down side .
but the reality is they are really on par at the end of the day with cash instrument returns not equity returns.
as i said , anyone can create their own index linked cd for a fraction of the cost , but don't expect them to compete against equities .
so here is how to do it...it was easier to do when rates were higher . there really is no magic to these and the bulk of the money is always going to be in some kind of fixed income with only a favorite tiny portion committed to equities .
we will call an equity linked annuity an EIA .
An EIA is an insurance contract that theoretically offers the buyer the opportunity to participate (to some extent) in equity market performance while guaranteeing a minimum payout at the end of the policy guarantee period. The extent to which the buyer participates in equity market performance typically varies year to year as does the minimum guaranteed crediting rate (AKA interest rate paid on the policy). This has proven to be a tantalizing pitch for many conservative investors.
The problems with these policies are that you have little control over how much you participate in the equity market; the policies typically have high early surrender fees and very lengthy surrender periods (10+ years is not uncommon); the internal expenses of these policies are quite high; you are exposed to insolvency of the issuer; the participation is typically limited to price changes in an equity index, with no compensation for dividends on the index; the participation in the index is capped at a predetermined level so that really big gains are truncated within the annuity structure; and the tax treatment of eventual distributions may be less than optimal.
How you can “roll your own” EIA, part 1:
By far, the simplest way to set up an EIA is to do it in an uncapped version. The simplest uncapped replication portfolio consists of a 1 year fixed income investment (such as a CD) and a call option on whatever equity index ETF you want exposure to. So let us assume you can buy a 1 year CD that yields (APY) 4%, you want exposure to the S&P 500, you have $100,000 to invest, and you want a minimum yield of 1%. To replicate an EIA, you would buy the following:
CD: You want $101k in a year, so you invest $101,000/1.04 = $97,115 in a 1 year 4% yield CD. In a year, the CD matures and you get $101,000, which is your desired minimum payout.
Options: Your CD purchase leaves you with $100,000 - $97,115 = $2,885. You take this amount and buy at the money 1 year call options on the S&P 500 index ETF (ETF symbol SPY). At the money means that the option exercise price is about equal to whatever the ETF sells for today. So with SPY trading at $137.93 as I write this in April 2008, we wish to buy April 2009 calls with a strike of $138. Such a thing doesn’t exist, so we will settle for the closest month we can get, which is March 2009. March 2009 calls (Symbol SFBCH) sell for $12 each and must be bought in contracts on 100 shares each, so you want to buy $2885/$1200 = 2.4 contracts, but must buy 2 contracts for $2400.
So you end up with a CD that will pay $101,000 in a year, $485 in cash, and options on 200 shares of SPY struck at 138. The options cover a notional amount of $138 X 200 = $27,600, so your “participation rate” in the index is 27,600/100,000 = 27.6%, meaning that you catch 27.6% of the appreciation of the S&P 500 through next March while bearing none of the downside. When the options are about to mature, you can sell them for cash, assuming the market has gone up and they are worth anything. Otherwise, you collect your $101,000 from the CD, have your $485 plus whatever interest it generated, and decide if you want to play this game again for another year.
Rolling your own, part 2:
Instead of having a small, uncapped participation in the index, you could have a larger participation but cap it at a given level. This is essentially what is done inside the EIA contract sold by most insurers. To replicate the EIA, you would buy the same CD as in the above example. However, the options portion would include:
1) Buy the at the money options on the index as in the above example
2) Sell out of the money options for the same expiration date and underlying ETF.
An example will be helpful:
Lets assume that you would be willing to cap your upside in return for a higher participation rate. That means you want to buy call options at the money ($138 strike) and sell call options at a strike that is about 10% higher ($152 strike). The $152 strike options currently trade for about $5.50 a share. So we buy:
4 contracts of the at the money options (SFBCH) for 400X12 = $4800
And we sell:
4 contracts of the 10% higher strike $152 (symbol SYHCV) and receive cash of $400X5.50 = $2,200.
Total out of pocket for the options is $4,800 - $2,200 = $2,600.
So you end up with a portfolio that consists of a CD that will pay you $101,000 in a year, $285 in leftover cash, and a package of options that gives you up to 10% of the upside on 400 X $138 = $55,200 worth of the S&P 500 index. Note that by capping your potential upside you have increased your participation rate to $55.2% of your $100,000, or double the uncapped version.
About taxes:
If this is done in a taxable account, the CD interest will be taxable and so will the gains or losses on the options. In this case, you would want to set up the portfolio for at least 1 year and 1 day to qualify for long term cap gains on the options. So instead of buying a 1 year CD, perhaps you would buy an 18 month CD and options that expired in 18 months. Inside an IRA or other tax sheltered account this would be of no concern, but your broker may not allow you to set up the capped EIA replication inside an IRA.
Other odds & ends:
- I have ignored transaction costs here. The CD should cost you nothing. Most discount brokers will charge less that $20 for an option trade.
- Brokers generally require customers to apply for approval before they can trade options.
- Note that you can buy options on any index you like that has an ETF with options traded.
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