A Safe Place to Grow Your Money
Would you like an investment that pays gains based on
the stock market, yet helps protect your principal when
the market declines?
It’s not every day that you find the opportunity for potential growth with true safety in the same financial
vehicle. Usually investors are compelled to make one of two choices, either they give up a degree of
safety in exchange for a greater potential for growth or they accept less growth in exchange for a higher
degree of safety. Thanks to an innovation in the insurance industry, you can have the potential high returns
available in the stock market and the security of a guarantee—it’s called an equity indexed annuity.
Equity indexed annuities are excellent alternatives for investors seeking safety in a low interest rate
environment or a volatile market. Here’s how they work, your return is based on the increase of a stock or
equity index, such as the S&P 500.1 If stocks rise, you benefit from the increase. If stocks fall, you do not
lose any money, most contracts guarantee a minimum return, typically 3%.2 This is what makes these
newer products so attractive to retired persons and to those approaching retirement.
Now, imagine this scenario: Suppose you and I take a trip to Las Vegas for a week. I decide to make
you the following offer. You can gamble at one of the casinos as much as you like for the entire week and I
will guarantee you in writing that no matter how bad you do you will not lose. In fact, I guarantee that you
will walk away from the tables with no less than what you started with, plus some interest. If you win, you
get to keep the winnings.
Would you take me up on the offer? I would imagine given that opportunity, you
would load up with casino chips as soon as possible. So, what’s the catch?
You can’t lose a dime, but the catch is, you have to play for the whole seven
days, otherwise you may have to give back a small portion of your chips. In
other words, if you invest with the intent to hold your investments for some time
down the road, index annuities can be a powerful investment. This brief
example is simplified, but in very basic terms, this is the concept behind equity
Obviously, there is no such thing as a free lunch, so the company that issues
the annuity will limit the maximum returns that you receive from a rising market
in return for the downside protection they provide. This limit depends on the
particular indexing method that the annuity company uses. The most common
method used to limit returns is something called the “participation rate.” For
example, the insurance company may set the participation at 90% (some
companies are as low as 50%), which means the annuity would be credited
with 90% of the growth experienced by the index. If the index gained 10%,
your gain would be 9% for that year. Essentially, you’re trading 100% of the
market risk in order to receive a share of the market gain.
In addition to the different participation options, there are index annuities that
use an “annual reset” method for crediting index-linked interest. This valuable
method allows you to lock in gains permanently in an up market. In volatile
markets where the index declines, the annuity simply resets locking you in at
the now lower index level. In fact, some index annuity renewals have been
reset at very attractive levels. The lower the reset is, the more opportunity there
is for future growth.
Let’s take a look at another tough time in the market and see how the index
annuity would have performed utilizing the annual reset method. One of the
best examples of a prolonged bear market was the 1970’s, in the 1973-74
downturn stock prices fell more than 40%. The S&P 500 closed at an all time
high towards the end of 1972 and it wasn’t until 1980 that these levels were retraced. So, if you bought at
year-end in 1972, it would have taken about 7 years to break even using the traditional buy and hold
technique. Utilizing a 90% participation index annuity with the annual reset method from 1972 to 1979
would have resulted in a return for those seven years of approximately 70%—even though the index had
not yet returned to its former high.
In today’s market environment it’s hard to beat an annuity that only goes up. Many seniors who fled the
stock markets, locked in gains and purchased equity index annuities. They are now waiting for an upturn,
which will produce further gains for them, not just a recovery to former highs. The use of these vehicles
has allowed them some comfort during market declines.
Due to the complexity of equity index annuities I strongly suggest you consult with a knowledgeable
investment advisor to see how they might fit into your financial plan.
1. The S&P 500 is an unmanaged broad based market index often representative of the stock market as a whole.
An investment may not be made directly in the index.
2. Equity indexed annuities are long term investments subject to possible surrender charges and 10% IRS early
withdrawal penalty prior to age 59 ½. Current interest earnings linked to the growth of the equity market. Minimum
return, principal value and prior earnings guaranteed by issuing insurance company, subject to their claims paying
ability, when held to the end of term. Risks include inflation and default risk.
All information herein has been prepared solely for informational purposes, and it is not an offer to buy or sell, or a solicitation of an offer to buy or sell any security or instrument or to
participate in any particular trading strategy. The Money Alert does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any
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convenience purposes only. The Money Alert is not affiliated with any of the firms or entities listed unless specifically stated. The Money Alert does not provide investment, tax or legal
advice. Please consult the appropriate professional regarding your personal situation.
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