Money Magazine Ask the Mole

Strategies for the shaky investor

Here's a plan that offers market returns with little risk. Hint: it doesn't involve high-cost insurance products.

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By the Mole, Money Magazine's undercover financial planner

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Have future topics for the Mole to address? E-mail him at themole@moneymail.com.
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NEW YORK (Money) -- Question: I hear the market is a good bargain right now, but I'm still very nervous about losing my money. Is there a way to get some market returns without taking so much risk?

The Mole's Answer: In a perfect world there would be a way to achieve market returns without the associated risk. Unfortunately, we don't live in that perfect world.

Capitalism dictates that you have to take a bit of risk with your money to get a higher return. The operative phrase here is "a bit of risk." Putting your money in a handful of individual stocks does not fall under said operative phrase and is just foolish. On the other hand, investing in the total global stock market and leaving it there for a couple of decades, swings the odds over to your side.

The problem many investors face is their tendency to panic and sell in times like these. The self-delusional belief that "this time is different" is the quickest path to self-sabotage.

While many insurance products may promise to deliver high returns without the risk, they usually only end up delivering high costs. The truth about those can't lose funds is that they are far more likely to build wealth for the planner selling them rather than for you.

But there is a way to get some of the market returns without taking much risk, and without making your financial planner rich. Here's how:

Let's say you have $10,000 to invest and want to make sure you get it all back in ten years. You can:

  • Put $5,888 in a ten year CD paying 5.44% APY.
  • Put $4,112 in a low-cost diversified stock index fund.

You may be wondering how I arrived at these numbers of roughly 59% fixed income and 41% equity. Well, it turns out that, as of the time of this writing, Discover Bank had a 10-year CD with this yield and, upon maturity, will be worth $10,000 if you let the interest reinvest.

Many people suggest using treasury zero coupon bonds for this strategy, but they only yield about 4.40% annually. Thus, as long as you can keep below FDIC insurance limits, finding the highest paying CDs is a much better strategy. I often go to http://bankdeals.blogspot.com/ to search for rates.

I can not stress strongly enough that you shouldn't let greed steer you toward higher rates that are not guaranteed by a U.S. government entity. If recent events have taught us anything, it's that some of these funds and bonds can go belly-up or at least lose value.

Now with the remaining $4,112, you can buy a total US stock market index fund or exchange fund such as the Vanguard Total Stock ETF (VTI), with annual fees of 0.07%. Alternatively, you can consider putting some of this portion in a total international index fund as well.

This works out especially well if you design it in a tax-advantaged way. Put the CD in your tax-deferred account such as an IRA or 401(k). Since CD interest is taxed as regular income, you're better off keeping it in a retirement account so you won't have to pay taxes until withdrawal. The stock market portion should be kept in your taxable account. For now, dividends are taxed at the lower capital gains rate and you can defer any gains until you sell.

With this strategy, you will always get back your initial investment, plus whatever the stock portion of the portfolio is worth -- market returns without the risk.

Remember that this isn't just the gain from the stock market, it's the gain plus the original $4,112 principal. Thus, even if the market is at the same value ten years from now, your $10,000 grew to $14,112. This represents a 3.5% annual return which should at least keep up with inflation. And if the stock market earns 8% annually, your total return on the $10,000 initial investment will be a respectable 6.6% return.

I've used this strategy for some time but never thought of the benefits it could offer in times of crisis like we currently are in. The psychological benefit from such a strategy is that we know we are going to get our money back. Hopefully that will give us the wherewithal to stay the course and hold off on the next panic sale.

The Mole is a certified financial planner and certified public accountant who - in the interest of fairness - thinks you should know what goes on behind the scenes in financial planning. Want to make contact? E-mail him at themole@moneymail.com. To top of page

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