Indexed annuities shine during market downturns and when retirement income is needed. In market downturns it is possible not to lose any money and to make money when everyone else is recovering. They are a major contrast to losing 20-30% and then having to recover for a year or three.
Equity Investments
Equity investments include all stocks, mutual funds, and any other equity positions that might be used. If you invested in a traditional equity investment, when the market goes down you lose money. Of course your broker will probably tell you that you haven’t lost any money until you sell but that is not really true. It is just supposed to make you feel better.
If your $100,000 investment is down to $60,000 and you earn 10% your only earn $6,000. You do not earn $10,000. You have lost money in the downturn and earning power. You have to recover your initial investment before you make any money at all.
If you are taking income the problem is just amplified by your withdrawal percentage. Lose 20% and take out 6% your investments are down 26%. If the market is flat it is not as bad. You are only down 6%. And that is not taking into account any mutual fund internal fees you might be paying. Now for indexed annuities.
Indexed Annuities
Indexed annuities are a different kind of investment. They do not go down with the market because they are not invested in the market. Your return is based on the market but not in the market. You are paid based on how whichever market index you choose performs. Usually, not always, it works out to be slightly lower than the general market return.
When the market does go down, your indexed annuity does not go down. The Illinois Buyer’s Guide To Annuities explains it well. The interest is locked in each year so that you are never at risk of losing money.
As the market falls and your friends are likely losing money, you are not. If the market falls 20%, you lose 0%. The main amazing difference is that when the market comes back up, you make money.
Example
If you invested $100,000 into an indexed annuity and the market went down 20% your investment is still worth $100,000. If the market then comes up 10% you would have about $109,000 (estimate based on the indexed annuity performing slightly under general market conditions). In the same scenario with your mutual funds or stocks you have lost $20,000, down to $80,000. The market comes up 10% and you earn $8,000 and are up to $88,000.
See the difference? In a down or down and flat market the indexed annuity has the potential to vastly outperform stock and mutual fund investments. But as you probably noticed, the indexed annuity underperforms the market when times are good. What to do?
Perhaps a solution is to use indexed annuities for their other guarantees and hope they grow in value as well. They could probably take the place of the growth and income portion of your portfolio or at least supplement it. They could also supplement your fixed income or safe asset base in your portfolio.
Which One Wins?
Indexed annuities vs. equity investments? In a down market, indexed annuities win for sure. In an up market the equity investments tend to win. The trouble is that we don’t really know when the market is going to take a downturn or have an extended up session. The solution is to diversify your portfolio. Diversify but always remember to never risk your retirement income-generating assets.
Disclaimer: Always seek individual advice from a licensed professional. This article is for general information purposes only and is not a substitute for professional advice.
Sources
Illinois Insurance Department, Buyers Guide To Annuities, State Insurance Website.
Join the Conversation