One of the biggest concerns for people approaching retirement is straightforward: What happens to my retirement savings if the market drops dramatically? 

You may still want the growth potential that comes with investing in the market, but once retirement is getting closer, the idea of watching a substantial portion of your portfolio disappear during a downturn can become much harder to tolerate.

So is there a way to remain invested while creating some protection against a major market decline?

The answer starts with understanding how downside protection actually works.

Think of It Like Protecting the Value of Your House

One of the easiest ways to understand investment options is to think about selling a home.

Suppose you own a house worth $1 million and you're worried that real estate values could fall. Imagine that someone offered you this deal: for $10,000, they would agree to buy your house from you for $1 million at any point during the next 90 days.

You wouldn't have to sell it.

But you'd have the right to sell it.

If your home's value suddenly dropped to $800,000, that contract could become extremely valuable because you would still have someone willing to pay $1 million.

If your home's value continued increasing, you could simply keep the house.

Options can function in a similar way with investments. They are contracts that can give someone the right to buy or sell an asset at a specified price within a particular period.  

That basic mechanism is behind many strategies designed to reduce investment risk.

Protection Isn't Free

The concept sounds appealing: keep your investments if the market rises while creating protection if the market falls.

But there's an important catch.

Someone has to take the other side of that contract.

And the further into the future you want that protection to extend, the more uncertainty the other party may be accepting.

Go back to the house example. Asking someone to guarantee a $1 million purchase price for the next 90 days is one thing. Asking them to guarantee that same price for the next two years creates significantly more uncertainty.

The same principle applies to investment markets. Longer time horizons can make certain options more expensive and may reduce the number of parties willing to take the other side of a transaction.  

Why Large Institutions Have an Advantage

Large insurance companies, investment banks and corporations can operate very differently from individual investors.

They may be negotiating transactions involving hundreds of millions or billions of dollars and can work directly with counterparties to offset specific risks.

In effect, one institution may be willing to take one type of risk in exchange for another institution taking a different risk. Through those transactions, they can create highly sophisticated hedging strategies.  

Individual investors technically have access to options as well. But having access to a financial product isn't the same thing as having access to the same pricing, terms or opportunities available to a major institution.

Understand What You're Paying For

This is particularly important when evaluating investment products marketed as providing downside protection.

The word protection can sound reassuring, but investors still need to ask important questions.

• What exactly is protected?
• For how long?
• What happens if the market drops beyond a certain level?
• What does the protection cost?
• What upside are you giving up?
• And who is ultimately responsible for making good on the agreement?

There is no universal solution that eliminates investment risk without tradeoffs.

For someone approaching retirement, the goal should be to understand those tradeoffs and determine whether the amount of risk in the portfolio makes sense for the retirement plan you're actually trying to fund.

If you're nearing retirement and want to better understand how your investments may perform during periods of market volatility, schedule a consultation with Leibel Sternbach.

Schedule your consultation at:
https://www.yields4u.com/pages/book