Ray Kotroczo of Legacy Financial of California gave us the benefit of his 35 years in the field of personal finance. His “financial commentary” started with a survey of recent business cycles and “where are we in the current economy, followed by a discussion of investments to protect against the current decline.

A Brief Survey of Recent Business Cycles

Cycles run for a long period and do not end quickly. The year 1933 marked the bottom of the Great Depression, with the stock market at approximately 34 points.  That year was also the start of a long-term recovery which ended in 1967, taking the market from 34 points up to 1,000 points.  During WWII, the economy had begun to come out of the Great Depression with the release of pent-up demand.

From 1967 to 1982, we witnessed a “bear market” with the market starting at 1,000 points and ending at the same level. The market fluctuated from the 400 to the 500 range with almost no-one making money.  Among the hallmarks of a “bear market” are very powerful rallies which eventually fizzle.  The highs are lower and the lows are also lower until excess inventory is purged.

From 1982 to 2000, there was an 18-year ”bull market” characterized by a housing boom, a banking boom and a technological revolution. Unemployment dropped and inflation declined.  During this period, both the market highs were higher and the lows were also higher.

In 1998, the Russian economy collapsed.  In this same year, the Long-term Capital Management Hedge Fund imploded but was bailed out by the Federal Reserve and various financial institutions, setting the pattern for our more recent bail-outs.

Where we are in the Current Economy

It is unlikely that many investors made money in the current decade.  From the year 2000 to the present, the market, even after a powerful rally, is still 15% lower than before.  We have a long way to go before the market recovers (unemployment being a lagging indicator).  We probably have from 6 to 8 years before we will “wring out the excess” and rise out of the bear market.  Housing, banking, retail, and other sectors are all “in the tank,” Moreover, from a debt perspective, California is a “basket case.”

Nevertheless, we will get through it as we are the wealthiest and most dynamic nation the world has ever known. The economy generally grows faster than does debt. Prior to WWII, American debt was estimated to be as much as 150% of GDP. Today this country’s debt is about 80% of GDP. By comparison, Japan’s debt is almost 200% of its GDP.

Investments to Protect You Against Decline

Warren Buffett’s two basic investment rules are: Rule Number One: “Don’t Lose Money, and Rule Number Two: “See Rule Number one.”  The key is “Don’t go backwards!” 

There are three basic types of annuities: 1. fixed annuities, 2. variable annuities, and 3. indexed annuities (his preference). Indexed Annuities are linked to stock market indices.  There are 36 stock market indices including Internationals, the Dow Jones, NASDAQ and the Standard & Poor 500.  With an indexed annuity, the investor does not own a share of an individual company, but rather a piece of a stock market index such as the S&P 500.

If you own an index annuity and the stock market goes down, the value of your annuity stays flat (never going below the value of the initial investment).  However, if the market goes up, so also does the value of the annuity (locking in your gains as the new “floor”).

The speaker displayed a chart showing the performance of an indexed annuity in relation to the stock market over a period of years.  From 2000 through 2002, the market went down while the indexed annuity maintained its value. There was a very powerful rally from 2003 to 2007 during which time the value of the index annuity also rose.  From 2008 until now, the market has been battered, but the index annuity investor has retained his/her gains while most investors have experienced losses.

The annuity company is able to make money on the gains made from its investments as there is a “ceiling” for investors.  Any gains over this “ceiling” serve as profit for the company.  The company also has an option method for protecting itself against market declines below the investor’s “floor.”

To supplement the safety features of the index annuity, the state of California guarantees every account up to $100,000.  If the investor has more than one account, each one is guaranteed up to this level. 

In the world of investments, Mr. Kotroczo recommends you to “diversity.”