For most of us, long-term investing is all about stocks and bonds. Where the younger you are the more you tend to own stocks as opposed to bonds. However, you also know that having all your assets invested in traditional investments such as stocks and bonds leaves you completely exposed to those not-so-nice financial crises that happen now and again.
You can protect yourself from the adverse effects of markets by mixing up your investing activities. For example, investing in two assets that are often not given the consideration they deserve, precious metals and annuities. These assets are also more likely to perform better than stocks in times of inflation.
Let’s have a look at the reasons that drive investors into precious metals and annuities. You’ve probably read in many investing books how important it is to invest with growth in mind. And, that without accepting the risk you cannot reap the rewards. Basically, you need to be fully invested in the market to build wealth.
Although both concepts are true in part, there is also another side to this story. You can still invest with wealth-building in mind in assets that are not so correlated to traditional markets. This factor helps you preserve your capital when the markets are in turmoil, and get you closer to debt-free living.
The stock markets do not like inflation, and the reason is simple. If inflation is high, so are interest rates. If a 10-year treasury bond is paying, let’s say 7%, the stock markets start looking a lot less attractive to many investors.
True, you say 10-year treasuries haven’t had a yield above 7% since the 90s. But economies change and an expanding economy will eventually put pressure on prices and send inflation higher. It’s a matter of when inflation hits, not if it will.
Precious metals are well known for their ability to at least stay up with inflation if not beat it. We can see in the chart below that from 1975 to 2017 inflation has risen by 375% while gold climbed 581%. There are some periods where the price of gold did not keep up with inflation, however, over the long term the precious metal has had a much stronger performance.
Annuities can also protect from inflation as they provide increasing income streams when you invest in inflation-indexed annuities. These annuities allow you to keep up with inflation which would otherwise chew away at your purchasing power.
The returns on these investments are adjusted to increase with inflation. The investment could have a provision to increase revenue by a fixed percentage each year, or revenues could be set to follow the increase in the Consumer Price Index.
Having sources of income that are different from the traditional stock and bond markets is a way to diversify risk by reducing your overall exposure to stocks. The risk reduction is achieved by gaining access to investments that have little correlation to the traditional markets your portfolio will usually hold.
Diversification means that your portfolio will have a less bumpy ride as the stock market goes through its best and worst times. The table below shows the correlation of returns between the S&P 500 versus Gold mining ETF (GDX), and Gold stock ETF (GLD).
The returns for gold show a very low correlation to those for the S&P 500, less than 0.07 for daily, weekly, and monthly data. Considering that the maximum correlation is 1, we can see that gold has almost no correlation to the general stock market.
Annuities that are indexed to inflation or have fixed payments also have very little or no correlation to the S&P 500. Low correlation can be assumed, as the revenue generated by these types of annuities does not depend on the broader stock market.
Capital preservation is just as important as growth, if your investments lose money capital growth is hindered. When the stock market takes a tumble your investments need time to recover before your capital starts growing again.
Keeping a portion of your portfolio in precious metals and annuities helps protect the capital of your portfolio when the stock market takes a beating. Precious metals are unlikely to be affected by sharp drops in stocks. As we have seen above they have almost no connection in performance to stocks.
Annuities with fixed payments are completely unrelated to stock performance, as they depend solely on the insurance company’s payments. This means that at least part of your retirement savings will continue to pay an income no matter the performance of the broader market.
A lot of investors feel that investing in precious metals could prove to be a drag on growth. Well, that depends on your time horizon, and when you started investing in gold. However, gold and precious metals continue to be in high demand for personal and for industrial use, and that doesn’t look like it will change any time soon.
The chart below shows the performance of gold, silver, S&P 500, and the Dow Jones Industrial Average since January 2000. Over the period in question, the precious metals have outperformed both stock market indices.
Worthy of note is the performance of gold during the last two crises of 2008 and 2020. During both periods, where stock markets experienced deep drops, gold had relatively limited negative returns before resuming its upward trend.
Gold, palladium, and platinum can be held in bullion or you can invest in a fund that does the work for you. Both of these investments can be held in an IRA or a 401k. The largest funds are gold-only funds, but you can also find funds that invest in various precious metals.
Probably the easiest way to gain access to precious metals is through an ETF. Exchange-traded funds have a high level of liquidity which allows you to buy and sell your stake in precious metals with ease and in a matter of minutes.
ETFs also come with relatively low management fees, which is an important factor that affects your bottom line. The largest ETF is a gold-only fund and currently holds $58.5 billion in assets, and the largest precious metals ETF holds $2.5 billion.
Most insurance companies sell annuities, so do some banks and brokerage firms. The largest risk you have when investing in this security is counterparty risk. You are going to be receiving payments from your insurance company for many years, leaving you open to the possibility of the company going bankrupt during that time.
To alleviate the risk of your counterparty shutting shop, and of you losing your money, buy your annuities from large and trusted companies that have been around for a long time.
Remember to check their fee structure. Apart from a management fee you will also be charged administrative fees, underlying fund expenses, and fees for special features. These features include things like long-term care insurance or guaranteed minimum income benefit.
Usually, annuities are not held in a 401k or IRA this is because they already have a deferred tax feature when you invest in them. You will only pay taxes on investment gains when you withdraw your money or receive payments.
We have seen how precious metals can act as a source of growth and a hedge against inflation. The increase in value of precious metals is determined by demand, people and corporations both want and need these metals. The demand trend has been going for a long time, and certainly looks likely to continue.
Annuities create an income stream that may last for a fixed period or indefinitely. Fixed annuities will continue to make payments when you retire regardless of how the stock market performs.
These two investments help produce a diversified portfolio which can greatly reduce your overall level of risk. They create a different source of income that has little or no connection to the broad stock market. Most importantly, they act as a hedge against inflation, which altogether helps protect your capital and can generate a positive return that lasts a lifetime.