Annuities as Bond Alternatives
For decades, a commonly cited rule of thumb for retirement portfolios has been the “rule of 100.” It states that individuals should hold a percentage of stocks equal to 100 minus their age. So, for a typical 60-year-old, 40% of the portfolio should be equities and 60% of the portfolio should be held in conservative or otherwise fixed-rate investments; bonds, treasuries, CDs, etc. However, with the large majority of these safe investments pay out roughly 2%-4%, many investors are keeping their exposure to equities disproportionately high for their age, or they are seeking alternative sources of fixed-income with more market-like returns.
During the 80s and 90s, interest rates were significantly higher, and the rates on most bonds and CDs were such that a retiree take their savings and get a high return from principal protected investments.
As we continue to observe the Fed’s noncommittal attitude towards stemming the incessant low-interest rate environment, it’s time to consider new sources of safe investments.
For our clients, we often present fixed-indexed annuities as a solution for the interest rate problem. An encyclopedia’s worth of information has been written comparing annuities of all types to market-based products. Certainly, the merits and drawbacks of annuities contracts have been exhausted by virtually every major financial publication, whether for or against the annuity as a market-based investment. However comparing fixed index annuities contracts to market-based investments is like comparing apples to oranges.
Consider this: All fixed-indexed annuities are backed by the claims-paying ability and financial strength of the issuing insurance company. Annuities are issued by insurance companies and have an overall excellent track record of paying out their benefits. Understandably, an investor should be aware of the financial solvency of the insurance companies before purchasing an annuity, but insurance companies are extremely well capitalized due to tremendously strict regulations placed on them and the layers of protection offered to consumers overall is incredibly robust, rivaling FDIC and surpassing the vast majority of privately held companies.
With an indexed annuity, the principal invested in the product is linked to a market index; basket of stocks, or other various underlying investments. This means that your principal will go up somewhat based on the underlying investment’s performance, but cannot go down due to market losses.
Since the potential for market loss is minimized, there is always a limit to the upside potential. However, compared to the current rates of CDs and bonds, even a portion of the market’s upside in the last two bull markets would have significantly outperformed most traditional fixed-investments.
Annuities aren’t for everyone. There are other concerns that need to be addressed on an individual basis with every recommendation, but fixed-indexed annuities do have a place in the financial portfolio, especially for those who subscribe to the rule of 100.
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The bottom line on EIAs is that the returns you think you’ll be getting if the markets rise may be nothing more than an illusion once all the contractual details are netted out. They’re basically being sold as alternatives to stocks, when the reality is that they’re much more of a bond-related instrument.