More than $10 trillion is invested in exchange-traded funds (ETFs) worldwide. The transparency of the ETF investment vehicle has made it appealing to investors for all portfolio sizes. Daily liquidity, tax efficiency, lower fees and transparency make it highly utilized.
Since 2018 Buffer ETFs have become one of the fastest growing segments of the ETF marketplace. Over 160 Buffer ETFs have recently attracted more than $30 billion in assets. These ETFs track a market index over a defined period of time while offering downside protection, known as a “buffer.” Investors can participate in the upside of the stock market, to a predetermined level, the “cap.”
If you are a conservative or moderate-risk investor who would like a certain level of downside protection while also having the potential to participate in the upside of the stock market, Buffer ETFs may be an excellent fit for your portfolio. Buffer ETFs should also appeal to investors nearing retirement or already in retirement who worry about market volatility and downside risk.
1. Choose your desired level of downside protection.
Buffer ETF issuers typically offer a “buffer” of 9-10%, 15% or 25-30%. So, you will want to first decide how much protection you would like during the outcome period, which is typically 12 months.
2. Choose the reference index you want to track.
Buffer ETFs track many different indices, so you need to choose the index you wish to track for the coming 12-month outcome period. Most Buffers track the S&P 500, but if you want to track the Nasdaq, small caps or foreign indices, they are also available for purchase.
3. Choose the Buffer series month to purchase.
Buffer ETFs are typically offered with either quarterly or annual reset dates. So, depending on when you are ready to purchase your Buffer ETFs, invariably many will already be in the middle of their outcome period, which means the outcome parameters will be completely different than they were on the reset date. Typically, you will want to buy a Buffer ETF on its reset date, so much will depend on the date when you are ready to construct your portfolio. Again, ideally you will purchase your Buffer series on the reset date – which is generally only one day per year for each Buffer series, but since there is a Buffer series available for every month of the year, you never need to wait long for a reset date to come around.
4. Check the outcome parameters on the issuing company’s website before making a purchase.
For example, if you are buying an Innovator Buffer ETF, go to Innovator’s website (www.innovatoretfs.com) and check the price and outcome parameters (buffer level and upside cap) prior to making a purchase. Remember, the outcome parameters will change throughout the trading day, so it’s important to know the exact parameters (downside risk and upside potential) before entering an order.
With over 160 Buffer ETFs available for purchase on U.S. markets, it’s important to understand some key features of Buffer ETFs, and more importantly, the optimal time to make purchases.
Buffer ETFs typically reset once per year. The four option contracts within the ETF wrapper expire and four new contracts are purchased with a fresh buffer and a new upside cap. Since option prices change throughout the trading day, the “defined outcome” will also change daily for Buffer ETFs.
The recommended date to purchase Buffer ETFs is the reset day (near the end of the trading day). Note, the reset day is different for each Buffer ETF series and often depends on the preference of the issuing company. You can view the reset date for any Buffer series on the issuing company’s Web site.
Although Buffer ETFs can be purchased on any day during the outcome period, it’s recommended to purchase a Buffer series on the reset day, and near the market’s close, to have the best chance at the same publicized outcome parameters provided by the issuing company.
Here’s an example as to how to structure a simple Buffer ETF portfolio:
Let’s assume you have $1 million to allocate to Buffer ETFs. You are a long-term investor, but you would like some level of protection in your portfolio while still having plenty of upside growth potential. Using two offerings from Innovator ETFs that provide 15% downside protection, the October and November Power Buffer 2023 series, here’s how you could time your purchases:
Innovator Power Buffer – October (POCT)
On September 30, 2023, POCT reset at the end of the trading day. So, a recommended purchase would take place in the final hour of trading on that day. The upside cap of POCT had been indicated at over 15% the week prior to the reset date, with downside protection on the first 15% loss over the coming 12 months.
You could allocate half your portfolio ($500,000) to POCT near the close of trading on September 30 to closely capture the outcome parameters for the next 12 months. A purchase near $33.95 would have allowed an investor to have the stated defined outcome provided by Innovator ETFs.
So, you now have half your portfolio allocated in a Buffer ETF. You have decided to allocate the remainder of your portfolio in the November Power Buffer series, which resets one month later, on October 31. As the reset date nears, indications as to the upside cap for the November series are also favorable – gross cap is indicated at 15.7% for the coming 12-month period, with protection on the first 15% loss. Note, the issuing companies typically provide upside cap estimates beginning one week prior to the reset date.
Innovator Power Buffer – November (PNOV)
On October 31, the day of the reset of the options within the ETF wrapper, you would make your purchase near the market’s close. Assuming your purchase price is close to $32.27, you’d achieve the same outcome parameters as Innovator publishes on its website.
You could obviously stagger your Buffer ETF purchases over several months or more and build a more diversified laddered portfolio – as far as the timing of the reset dates. You can stagger purchases across many months if you wish. Still, if the upside cap is attractive when you have cash available to invest, there isn’t much reason to delay purchases, unless you believe markets are very extended, overvalued and due for a sizeable correction. If not, one could argue to go ahead and allocate your entire portfolio within 1-3 months.
There are many ways to structure a Buffer ETF portfolio. A good start is to simply purchase one or two Buffer series, with attractive upside caps, with the intention of holding them at least for the outcome period, and ideally as long-term investments too.
Caveat Emptor (Buyer Beware): Do not purchase Buffer ETFs without first knowing the exact defined outcome parameters. These are provided daily by the issuers of the Buffer ETFs. Since the parameters change daily and throughout each trading day, you will always want to check them before making a purchase.