Joseph Nicholas Wambugu

How Fixed Indexed Annuities Will Beat Out Bonds Over the years, annuities have caused financial advisors lots of anguish. What’s more, low bond yields make it difficult delisting clients who are fast approaching retirement. Even so, advisors have reason to rejoice. Recent developments indicate that soon, fixed indexed annuities (FIAs) will have better returns over bonds. If that happens, then it will be easier smoothing out a portfolio’s performance. But why will that be possible? It is because FIAs have better protection against stock market fluctuations. A majority of investors believe that risky portfolios perform better. Although derisking is desirable, it is not a prudent decision. Low bond returns of 3% make it difficult finding an environment to derisk comfortably. However, adding FIAs to a portfolio remains the only viable option for addressing fluctuating stock market returns. But what are fixed indexed annuities? Fixed indexed annuities are tax-deferred investment instruments issued and guaranteed by an insurance company. Instead, interest rate pegged returns, FIA returns depend on the performance of a stock market index. Typically, FIAs offer a three-year haven for your investment spread out for a period between nine to 12 years. But there are penalties if you choose to opt out early from FIAs. In contrast, uncapped products are subject to a participation rate as well as an index floor. During years of good performance, fixed indexed annuities post impressive as they have better equity exposure in comparison to other products. Conversely, a risky stock market results in reduced participation rates and decreased returns. Fortunately, your returns are guaranteed to never fall below 0. Capital Management’s hypothetical simulations for the years between 1927 and 2016 indicate that long-term government bonds had annualized returns of 5.32%; Big Cap stocks had 9.92%, in comparison to FIAs’ 5.8% in a period flout with stock market rises and falls. FIA Hypothetical Net Return -) Big Cap Stocks Long-Term Gov’t Bonds Annualized Return 9.92% 5.32% Standard Deviation 19.99% 9.97% Minimum Annualized 3-Year Return -27.00% -2.32% Maximum Annualized 3-Year Return 30.76% 23.30% FIA 5.81% 10.01% 0.00% 27.56% Source: 2017 SBBI Yearbook, Duff & Phelps; Zebra; AnnGen Development, LLC Also, Capital Management simulated the performance of different portfolios in below median bond return conditions against above median bond return conditions. Between 1927 and 2016, both stocks and bonds returned 7.6% in comparison to 60/20/20 for stocks, bonds, and FIAs. Over the same period, a 60/40 stocks and fixed indexed annuities portfolio returned 8.63%. But during periods of above median bond returns, adding FIAs to a portfolio reduces its returns considerably (See chart below). This occurs during periods of falling yields. Often, bonds outperform fixed indexed annuities because capital gains comprise a large chunk of their returns. Below Median and Above Median Bond Return Environments -) Below Median Above Median Bond Overall Period Bond Return Environments Average Average Return Environments Return Average Returns 1.87% 9.00% 5.43% Long-Term Gov’t Bonds Big Cap Stocks 11.43% 9.84% 10.63% FIA 4.42% 7.55% 5.98% 60/40 (Stocks and Bonds) 60/20/20 (Stocks, Bonds, & FIA) 60/40 (Stocks & FIA) 7.60% 8.12% 8.63% 9.50% 9.21% 8.92% 8.55% 8.66% 8.77% Source: 2017 SBBI Yearbook, Duff & Phelps; Zebra; AnnGen Development, LLC Preferably, you should avoid investing only in fixed indexed annuities. Instead, your portfolio should combine stocks, bonds, and fixed indexed annuities. What’s more, these products can help you protect a portfolio against stock market fluctuations. Recent positive performance of the stock market will see bonds performing better in the long term. Despite high market participation, there is speculation that the market is highly priced right now.