Fortunately, there are newer, simpler and less costly varieties of EIA contracts offered to the fee-only community. Still, I’m still not sold. The idea of using an EIA to improve fixed income returns seems a bit bipolar to me.
On one hand, the pitch is that clients should use EIAs because the market is too risky to go near, but on the other hand clients are told an EIA should give them better returns because the market is very likely to juice the returns. The stronger an agent suggests that better than bond returns will be the result, the stronger they are suggesting the equity markets aren’t so scary.
A much simpler approach is to build a good bond or bond fund portfolio and if you want to try to get a boost from stocks, invest a little in stocks. Twenty percent may even be high for a really conservative investor but nonetheless, a simple 20/80 ratio of the S&P500 and 5-year treasury bonds annually rebalanced has never lost money over a 5-year period (1926–present). Most EIAs want the money tied up longer than that. With lower capital gain rates and low cost ETFs and mutual funds, anyone can implement a similar strategy with far less complication, cost, restriction and taxation over the life of the investment.
Stop-Loss And Stop-Limit Orders To Protect From Losses
I often see stop-loss and stop-limit orders presented as ways to protect value when a client has doubts about the prospects for an equity holding. From what I’ve seen neither of these orders protect from losses all that well.
First thing I want to do is examine the effect of executing the simplest tactic for avoiding a loss—sell the stock. With a zero basis and applying the maximum federal long-term capital gain rate, selling a stock owned for more than a year means the client keeps 76.2% of the current value. If the basis is 50% of the value, 88.1% is left after the sale. It is a good practice to consider the compare outcomes to the scenario of simply selling the stock.
For loss limitations purposes, a stop order is always set at a price lower than the current market price. A stop-loss can fail as a loss limitation tool because hitting the stop price triggers a sale but does not guarantee the price at which the sale occurs. Once the stop price is breached, the order becomes a market order and the stock can sell at an even lower price. This happens often when stocks gap down at the open or due to breaking news intraday.
To combat this, you can place a “limit” on the stop-loss by which you will sell for no less than the limit price. The limit, however, does not guarantee a sale. Once the stop price is breached, if the market price is below the limit price, the sell order won’t be executed at all.
Regardless of whether the stop order executes or not, the result is often inferior to simply selling now. If the stock sells due to the stop, the client will always net less selling at the lower stop price. If no sale occurs, no loss limitation was achieved at all.
Dan Moisand, CFP, has been featured as one of America’s top independent financial advisors by Financial Planning, Financial Advisor, Investment Advisor, Investment News, Journal of Financial Planning, Accounting Today, Research, Wealth Manager, and Worth magazines. He practices in Melbourne, Fla. You can reach him at [email protected].