Buffer Funds Promise Retirees a Safety Net. The Data Finds Holes

Trump rejected Iran's peace offer. Oil climbed. The 10-year yield hit a 19-year high. Stocks fell.

The quick scan: The week opened on the back foot. Over the weekend, President Trump rejected an Iranian proposal to reopen the Strait of Hormuz and end the war, though he told Axios he expects more talks this week. Oil rose, Treasury yields pushed to levels last seen before the Global Financial Crisis, and all three major indices closed lower, with more than 65% of US issues declining.

S&P 500: -0.77% to 7,683.69 – a broad, orderly decline as higher oil prices and bond yields weighed on sentiment ahead of this week's PCE inflation and jobs data
Dow Jones: -0.67% to 51,481.51 – fell 347 points; Boeing hit a 2026 low during the session after reports the FAA is delaying certification of its 737 MAX 10
NASDAQ: -0.92% to 26,820.38 – the weakest of the three as tech gave ground, even as Nvidia announced a record $150 billion addition to its share buyback programme

What's driving it: Bonds, more than oil. The 10-year Treasury yield rose to about 5.2%, its highest level since 2007, and the 30-year reached a level not seen since 2004. When a government bond pays more than 5% with none of the stock market's drama, shares have to work harder to justify their prices. Oil added to the pressure: Brent settled near $98 a barrel after the peace proposal fell through, keeping inflation fears alive. Fed Governor Lisa Cook fed those fears too, saying AI-driven investment is adding to inflation and that the labour market appears well placed to handle higher rates. With PCE inflation and jobs data due this week, investors are bracing for rates to stay higher for longer.

Bottom line: A 0.8% down day is not a crisis, but it is the kind of day that makes a product promising a floor under your losses look appealing. Today's article looks at what that floor has actually cost buyers over time. One detail from this session sits alongside it: with bond yields at 19-year highs, the plainer option of holding less in shares and more in steadier assets is better paid than it has been for years. That is context, not a recommendation.

What Is That Safety Net Under Your Portfolio Really Costing You?

The scoop: Picture the pitch. You get most of the stock market's upside, up to a ceiling. If the market falls, the first slice of the loss is absorbed for you. No stock picking, no timing, just a neat payoff diagram with a flat floor where the scary part used to be.

For anyone who lived through a bad market year with most of their savings in shares, that diagram is soothing. It is why buffer funds, sold as "defined outcome" products, have become one of the fastest-growing corners of the fund world. By May 2025, Morningstar's Defined Outcome category held 401 funds and about $70 billion. And according to a paper published in The Journal of Portfolio Management last September, the people buying them most eagerly are retirees and retail investors. In other words, us.

Once the diagram meets the real world, does the safety net hold?

What sits inside the box

It is a bundle of four options wrapped around one stock index, and each piece has a job.

The first is a long call option, bought deep in the money. That gives the fund most of the index's movement, up and down. The second is a put option bought at today's price. That is the buffer, the part that pays out if the index falls. The third is a put the fund sells at a lower price, which marks where the buffer ends. The fourth is a call the fund sells at a higher price. That is the cap. Past it, the upside belongs to someone else.

Selling those last two options brings in money that pays for the protection. So you are not buying insurance with cash. You are paying for it with your best years in the market, and with any losses deep enough to fall through the floor.

Who ran the numbers, and why that matters

The paper comes from Cliff Asness, Jeffrey Cao, Antti Ilmanen and Dan Villalon of AQR. They used Morningstar's data and tested every fund with at least 24 months of history, up to the end of April 2025.

AQR is an investment firm that sells competing strategies, and its authors have been publicly combative on this topic. Their method is transparent and the data is not theirs, but the conclusion suits their business. The other side of the argument has its own problem: most of the research praising buffer funds comes from the companies that issue them. Neither camp is neutral, so read what follows as one research team's evidence, not the final word.

Finding one: less reward for the ride

The first test used the Sharpe ratio, which simply asks how much return you got for each unit of bumpiness you sat through. The average and the median buffer fund scored lower than the very index it was built on.

And the gap did not shrink with time. The longer a fund's track record, the worse the comparison became.

Finding two: the buffer leaked

What happened when the index fell but stayed inside the buffer zone, exactly the scenario the product is designed for?

Most of the time, the buffer funds still lost money.

When losses were bigger and broke through the buffer, the funds did worse than their own payoff diagrams implied. The flat floor on the brochure turned out to be more of a gentle slope.

Finding three: the boring alternative won when it counted

The authors looked at the three largest market drawdowns of the past decade, the moments a buffer is supposed to earn its keep. They compared buffer funds with a simple mix of stocks and cash, set up to carry the same amount of market exposure.

The plain mix generally came out ahead.

Where the returns go

The authors break a buffer fund's expected return into four parts. Start with the index return. Then subtract three things.

The first is the volatility risk premium. Anyone who has bought travel insurance knows the insurer expects to profit on average. Options that protect against falls are the same: over time, the buyer tends to pay more than the protection turns out to be worth. A buffer fund is, on balance, a buyer of that insurance.

The second is option trading costs, paid every time the options are bought, sold and rolled. The third is fees. The median adjusted expense ratio in the category was 0.79% a year, a good deal more than a plain index fund charges.

Some funds compare themselves with the price return of their index, which leaves out dividends. The authors call that a lower hurdle. It is a bit like a runner timing himself on a course that skips the last lap.

The caveats

These are averages across funds and across roughly a decade of data. They do not say every buffer fund failed every investor in every period. They are also findings about US-listed products.

What the paper is really about

Strip away the options and the acronyms and a very human pattern remains. Losses hurt more than gains please, and the hurt gets sharper when there is less time to recover. A product that promises to take the sting out of a bad year will always find buyers among people like us.

But feeling protected and being protected are different things. The cost of the feeling is hard to see, because it arrives as gains you never received rather than as a bill you have to pay. The comfort shows up on the brochure. The price shows up years later, in a gap you may never think to measure.

The paper's quiet lesson is an old one. When a simple choice and a complicated product promise the same thing, check the simple choice first. Complexity is not always a con. It is always something you pay for.

Actionable takeaways for L-Plate Retirees:

• Separate the feeling of safety from the fact of it. Before any product earns a place in your portfolio because it makes you feel calmer, ask what it has actually delivered over a full market cycle, not what it promises in a chart.

• Know what you are giving up, not just what you are getting. With these products, the payment is a cap on your best years and a floor that ends where the buffer ends. If you cannot say in one sentence what you are surrendering in exchange for protection, you are not ready to buy it.

• Check the plain option first. If you want less exposure to a falling market, the most direct lever is simply holding less in shares and more in cash or other steadier assets. In the worst drawdowns of the past decade the research found it generally did the job better on average.

• Look at the benchmark before you look at the results. A product measured against a lower bar will always look better than it is. When anything reports its performance, find out what it is being compared with, and whether that comparison includes dividends you would otherwise have received.

• Treat evidence from interested parties with equal care. This study comes from a firm that sells competing strategies. Most of the research defending these products comes from the firms that sell them. Both deserve a question about who benefits from the conclusion before you let it shape a decision.

• Match the fix to the fear. If a bad year would genuinely derail your retirement, the answer is more likely a change in how much risk you hold overall than a clever product layered on top. Talk to a licensed adviser about your own situation. This is not investment advice.

Your Turn: 
If a product promised to absorb the first part of any market fall, how much of your future upside would you really be willing to give up for that comfort? 
Have you ever bought something mainly because it made you feel safer, and later found out what that feeling had actually cost you? 
When you think about protecting your savings from a bad year, is your instinct to reach for a product, or to rethink how much risk you are carrying in the first place?

👉 Hit reply and share your thoughts – your answers could inspire fellow readers in future issues.

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