How Do You Protect Against Market Drops? | The Informed Investor 9

Episode 9: Enticing pitches for "buffered" strategies promise protection against downside risks in stocks. Are they worth it? Should investors sacrifice some upside for lowering the risks of losing money? So-called "defined outcome strategies" offer a way to hedge downside equity risk in exchange for lower participation during market upswings. There is typically a downside protection amount (the "buffer"), ranging from 10% to 100%, and a capped potential upside over a set period, typically one year. The income potential of these strategies may be attractive for some investors, and softening the blow during equity market downturns is appealing for most investors. But there is more than one way of targeting downside protection. Historically, fixed income investments across a wide range of sectors have had a positive average return when equities have had a negative return. Since 1976, for example, the Bloomberg US Aggregate Bond Index had an average return of 4.53% in years when the S&P 500 Index had a negative return.

Some may question the diversification benefit of fixed income based on recent episodes where stocks and bonds moved in the same direction, like 2022. But it's important to remember that volatility reduction in portfolios from an allocation to fixed income has been largely unconnected to whether the returns of stocks and bonds moved in the same or opposite directions.

Buffered strategies and traditional equity/fixed income allocations both aim to provide downside protection at the cost of upside participation. The tradeoff between upside participation and downside exposure is comparable whether using defined outcome strategies or a simple mix of stocks and bonds.

What's not similar between these two approaches is the overall performance—in the five-year period ending June 30, 2025, a 60% stocks/40% bonds strategy outgained several types of buffered strategies, which typically come with higher fees.

In Episode 9 of "The Informed Investor," Dimensional's Mark Gochnour, Head of Global Client Services, Wes Crill, Senior Client Solutions Director, and Jake DeKinder, Head of Client Communications, analyze the allure of buffered strategies as well as the risks and costs of seeking downside protection.

LINKS FROM TODAY'S EPISODE:

The Informed Investor on YouTube https://www.youtube.com/playlist?list=PLCyJr6FFig- Wes Crill on LinkedIn https://www.linkedin.com/in/wes-crill-77a49417/

Jake DeKinder on LinkedIn https://www.linkedin.com/in/jake-dekinder-cfa-4105b98/

Learn more at https://www.dimensional.com/