What are Defined Outcome and Buffered ETFs?

What are Defined Outcome and Buffered ETFs? In this episode of Berry’s Bites, Chris Berry answers the question: What are Defined Outcome ETFs/Buffered ETFs and why may they make sense now as part of your portfolio?

 

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Episode Transcript:

 

What are defined outcome ETFs, and buffered ETFs, and why may they make sense as part of your portfolio?

Here’s how it works. Let’s say we put in a hundred thousand dollars and it follows, let’s say the s and p. Most people have heard of the s and p 500 pretty common index, and then what happens is that we have some type of defined outcome, so let’s say 13 months down the line. Ideally, we leave this money in for over a year, otherwise, we have to worry about things like short-term capital gains, which show up as income.

What it does is it builds on this downside protection where let’s say the buffer is 15. And let’s say that what happens is the market goes down less than P 500, drops 10%, but because it’s within the buffer, you would still have fewer fees, still have your a hundred thousand dollars because it’s within that buffer of 15%.

Now, of course, there’s a trade-off for this, and that trade-off would be a cap, depending on the tool, depending on the month, and depending on the timing. And I’m just making up numbers right now, but let’s say there’s a 15% cap, so we have a 15% buffer, 15% cap, meaning that if let’s say the markets go up 10%, you’d be walking away with $110,000 fewer fees.

Now, if the market goes up, 20%, you would be capped at that 115,000 or 15%. So that’s where the cap comes into play. Now, let’s say the markets go down 20%, that’s over the buffer. You would only lose 5%, and so you’d be walking away. If the markets dropped 20%, you’d be walking away with 95,000. So what makes these tools interesting is that you have this buffer aspect.

We’re all right. We’ve had the drop last year, the big drop. As long as we don’t have another devastating drop, and even if we do, we’re limiting the downside, but still, you could have a 15% cap, like you could make up to 15%. So realistically, you’re looking at anywhere from zero. If the market drops anywhere from zero to 15% gain, I’m not saying everyone should put all of their money into something like this, but given the market volatility, then also looking at this maybe as a bond alternative.

And this isn’t like a fixed index annuity or it’s not based on insurance or anything like that. It’s just tracking an ETF or investment and building in some downside protection. And this takes different forms. One version is what’s called buffer ETFs, where you have this buffer. So that’s one example of a tool that kind of works this way.

Another tool that works this way is structured notes, and all of these can be inside your investment portfolio. Like we. Our main custodian is TD Ameritrade. You could track how this is doing at TD Ameritrade if we’re working together. So buffer ETF, structured notes. These can be inside of trusts as well.

These could also be what’s called investment trusts, but all of these really kind of work the same way. It’s just different ways to get to the same outcome of building on some downside. Protect. But still getting relatively good opportunities for growth and especially we think things are going to come back, but looking at the next year or so, chances are we might have some continued volatility.

 

 

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