How to invest in stocks without risk in 2014

For those who don't think it's possible to invest in stocks and still be assured of getting your principal back, think again. In fact, it can be done with an average expense ratio of 0.02 percent annually, along with high tax-efficiency, and all guaranteed by the U.S. government.

Here are a couple of strategies, both employing what I call a "build your own annuity" approach. The approach involves a mix of a long-term risk-free certificates of deposit (CD) backed by the FDIC and a low cost stock index fund such as the Vanguard Total Stock Index ETF (VTI). To illustrate how this works, I'll use a $10,000 investment for all examples. Feel free to add or delete a digit or two.

As of December 27, 2013, Fidelity.com showed the highest ten-year non-callable CD was paying 3.30 percent annually. This means that a deposit of $7,228 will grow to $10,000 in ten years. Take the remaining $2,772 and buy the stock index fund. In this way, you'll have a U.S. government guarantee to get your money back in ten years. More importantly, if stocks turn in an eight percent annualized return, your portfolio will be worth nearly $16,000 in ten years, amounting to a 4.80 percent annual return.

It's reasonable to assume that one could do even better by taking a little risk. Let's face it, if stocks are worthless in ten years, that would be a pretty good indicator that capitalism has failed and taken the U.S. government along with it. So if we presuppose that the worst total return stocks would turn in over a decade is a 50 percent loss, you could invest a greater proportion in the stock index fund. Putting this in perspective, the S&P 500 would have to lose about 60 percent for the total return (which includes dividends) to lose half its value. 

This allows a $5,659 investment in the CD and a $4,341 investment in the stock index fund.  If stocks do become worthless, you are left with only $7,829 in the CD and a loss of $2,181, but money is probably worthless in this scenario anyway. On the other hand, if stocks lose 50 percent, you get your full $10,000 back. An eight percent annualized return for stocks yields a total portfolio annualized return of 5.57 percent, making your portfolio worth over $17,200. Other scenarios are shown in the chart.

returns from building your own annuity.jpg
Returns from building your own annuity
CBS MoneyWatch calculations
This risk free investing technique has an overall annual expense ratio of about 0.02 percent and the CD portion is backed by the U.S. government, rather than an insurance company that might not even survive the 50 percent stock decline scenario. In addition, locating the CD in a tax-deferred account and the stock index fund in the taxable account builds in tax-advantages far superior to annuities

Perhaps the biggest advantage this strategy has is emotional. When stocks tank, knowing that the total principal is guaranteed up to FDIC limits may give investors the strength not to panic.

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    Allan S. Roth is the founder of Wealth Logic, an hourly based financial planning and investment advisory firm that advises clients with portfolios ranging from $10,000 to over $50 million. The author of How a Second Grader Beats Wall Street, Roth teaches investments and behavioral finance at the University of Denver and is a frequent speaker. He is required by law to note that his columns are not meant as specific investment advice, since any advice of that sort would need to take into account such things as each reader's willingness and need to take risk. His columns will specifically avoid the foolishness of predicting the next hot stock or what the stock market will do next month.

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