Nellie S. Huang – Kiplinger’s Personal Finance
Kiplinger’s Money Power
If it’s true that the psychological pain of losing money is twice as great as the pleasure you feel when you make a profit, then there’s an exchange-traded fund for that. A new class of ETFs, called defined-outcome or buffered ETFs, limit your losses in the stock market in exchange for giving up some of your potential gains.
And they’re growing in popularity. The first defined-outcome ETF launched in 2018. Today, there are nearly 270 funds, with $47 billion in aggregate assets.
Interest in these ETFs ramped up after both stocks and bonds turned in terrible returns in 2022, and investors sought ways to build some defense into their portfolios. But buffered ETFs also appeal to risk-averse investors who want to keep a toe in the stock market. Word is, recent and soon-to-be retirees, who are staring down a possible 30-year stretch for their money to last, are interested.
“You can’t maintain your standard of living for that long without earning equity-like returns,” says Matt Collins, head of ETFs at PGIM Investments. “Some are willing to take some risk to get that exposure, but not a lot. And if you can offer them a narrower range of outcomes, it gets them a little closer to being comfortable with exposure to large-company U.S. stocks.”
Buffered strategies aren’t new. These approaches have existed for years in mutual funds and in annuities and other products sold by insurance companies. But the ETF versions are accessible to all investors. Innovator and First Trust were the first firms to offer buffered ETFs; AllianzIM, Pacer and TrueShares entered the market in 2020 and 2021. More recent joiners include iShares, PGIM Investments and Fidelity.
Trouble is that these actively managed strategies require a lot of explaining. They’re not typical stock or bond funds. In fact, they’re something in between, more like alternative investments.
“Investors need to reach a level of understanding to make sure they have the right expectations,” says Ryan Issakainen, First Trust’s ETF strategist. That’s part of the reason the bulk of defined-outcome ETF buyers these days are financial advisers who purchase them on behalf of their clients, not individual investors. And that might be a good thing.
Buffered ETFs come in a variety of risk-reward combinations. The majority offer a certain cushion on losses over a 12-month stretch in exchange for a give-back on gains. But others tweak the formula: Some allow you to capture more of the stock market’s gains; others focus on downside protection. ETFs that let you hedge against stock losses and guarantee a payout—sort of like a dividend — have just joined the mix.
“There’s a super-wide array of ways to use these products,” says Graham Day, chief investment officer at Innovator ETFs. “They can be used as a complement to a stock portfolio, other times as bond alternatives, or other times as an alternative-investment sleeve” that zigs when other parts of your portfolio zag.
(Nellie S. Huang is senior associate editor at Kiplinger Personal Finance magazine. For more on this and similar money topics, visit Kiplinger.com.)
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