It’s Halloween, so let’s talk candy. Structured investment products known as “Boomer Candy” have been popping up in the news this year.
And, no, Boomer Candy isn’t a reference to candy corn or circus peanuts. It’s a somewhat pejorative term that’s been slapped on a growing class of investment products that offer the upside of long-term stock returns, but without some of the downside risk.
And by the way, I’m a Gen-Xer, so I don’t have a dog in this generational fight that’s gone on between the Boomers and the Millennials. So, don’t shoot the messenger.
Also, I love candy corn and circus peanuts, which most people think are gross. But, really, you’re missing out.
Anyway – name aside, should you throw some Boomer Candy into your plastic, jack-o-lantern-shaped trick-or-treat basket of investments?
Let’s look deeper.
What Is Boomer Candy?
Boomer Candy refers to structured ETFs that offer the upside of stock investments, but with some buffers that can limit losses if there’s a market drop.
Sounds great, right?
The upside of the stock market? Check.
Downside protection? Check.
Why wouldn’t you invest in something like this?
Well, of course, the devil’s in the details.
How Do They Pull This Off?
When you look under the hood, these funds have to buy a couple of things to make this work:
- A stock index of some sort, and
- A derivative of some sort.
The stock bit is fairly straightforward. The fund just buys stocks in some form or another.
The derivative part is more complex. It typically comes in the form of a put option.
A put option is a financial instrument that gives the holder the right (but not the obligation) to sell an underlying asset at a specified price. That underlying asset would be the stocks they just bought.
Having this put option gives the fund the ability to limit their losses if the stock market tanks.
So, think of it this way: they’re buying an insurance policy for stock losses.
And to take it further, some of these strategies may also sell call options. A call option gives the holder the right (but not the obligation) to buy an underlying asset, in this case the stocks the fund already owns, at a specified price.
Why would these funds sell call options? Well, selling these things generates money for the fund. They already own the stock – and if there’s not much movement in the stock’s price, then it’s more income for them, adding to the return of the fund
This is also known as a “covered call” strategy.
As you can see, these derivatives start complicating things pretty quickly.
You Can’t Have Your Cake and Eat It Too
Just like everything that sounds too good to be true, these Boomer Candy products have some issues:
- Many of these products cap your potential gains in a really strong market. So, you may be giving up more in a good year than you would have lost in a moderately bad one.
- The cost of buying the put options will naturally reduce the fund’s returns. So, you’re limiting your upside right off the bat.
- These funds also have higher trading costs and expense ratios than your typical passive investment strategy, which, again, will lower your returns.
- You might not even getting the dividends of the underlying stocks, which are likely going toward the purchase of those put options.
So, while the allure of stock-like returns with limited downside sounds amazing, just like everything, there’s no such thing as a free lunch.
What Should You Do Instead?
While these Boomer Candy products do deliver on limiting losses compared to their corresponding stock index, there’s an easier and more effective way to do this:
Just buy bonds.
I hate to be like the dentist that puts a toothbrush in your Halloween basket, but put down the Boomer Candy. And eat a vegetable instead.
That’s all for this month. See you next time.
