Are indexed annuities too good to be true?

February 6, 2011
Heads you win; tails you don't lose

Here's an idea:  take your entire retirement nest egg to a casino and risk it all for the chance to get some great returns.

Would you do that?  I sure hope not.  You'd be an idiot to risk your entire retirement at some casino table.  Yet most people do exactly that when they put their retirement accounts into the stock market.  You can win big --- or lose it all.

What if there were a new casino that didn't pay you all of your winnings when you won, but... they never took a penny from you when you lost.  It might work like this:  for every $100 you win they pay you $30 and they keep $70.  Hey, probably doesn't sound that great until you consider this:  every time you lose a hand they let you keep all your money.  They NEVER take a penny from you when you lose!

Now, think about it:  how long could you play at a table like that?  FOREVER!  At that table you can only WIN!  Would you feel good about that?  I think you probably would.

But, your kids might say, "But, if you played at a normal table you could (should I put that in bold?), you could end up with so much more!"  Your neighbor might come home from a gambling junket and brag about how much money he won and tease you about playing at the table for people who only win 30% of their winnings.  And you might start to feel stupid.

"Geez," you might say, "maybe I should play at the big boy's table too!"  Put another way, you might let greed get the better of you.  What are the seven deadly sins again?  Do I need to remind you?  

The moral of the story is simple.  You CAN earn roughly a third of stock market returns and never lose a dime when markets take their inevitable crashes and when they do, you can have the last laugh when you get to keep every penny of winnings you already earned while your greedy acquaintances paste phony smiles on their faces and pretend it doesn't matter. 

February 6, 2011
Actual Returns of Index Annuities versus Alternatives

Indexed annuities have a lot of detractors and naysayers.  Their thinking is that an annuity with earnings caps and "less than 100%" participation in stock market gains combined with no dividends makes them weak, money-losing investments.  Well, let's not allow the facts to confuse them.

Fact:  according to research published by the Wharton School in 2010, from 1997 through 2007, "the five-year annualized returns for FIA’s averaged 5.79%. This compares to 5.39% for taxable bond funds and 4.73% for fixed annuities. "   But wait, I said against the "stock market."  What were the five year average returns of the stock market during the same period of time?  Using the S&P 500 the average of the five, five year holding periods was 8.99%.  Which means that an indexed annuity, having none of the risk of the stock market, delivered 55% of the return.

But wait... measuring through the end of the five year period ending in December of 2007 ignores the fact that the markets lost over 50% of their value in the following year.  That decimated returns for equity investors but indexed annuity owners didn't lose a penny, putting them ahead of equity investors.  And when the markets came back, indexed annuity were making more money, while equity investors were merely making money back and trying to get back to where they were before the big loss.

Studies have shown that if you are able to simply avoid all losses, you only need to earn between 27% and 30% of the gains in the good years and you'll end up ahead of the game.  Simply put, that's what a good index annuity does. 

 




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