gettyIn the current volatile economic landscape, many individuals find themselves grappling with a sense of uncertainty. According to a recent Harris Poll, the majority of Americans still express concerns over the recent bank failures, the U.S. economy, inflation and the looming threat of a recession.
In light of the recent volatility of traditional bank bonds, one of the most widely discussed strategies involves substituting them with resilient and reliable fixed-indexed annuities. But before we dive into FIAs, it’s important to examine why a once-trusted investment vehicle has people scrambling to move their money.
Fear Of The Failing Bond
During turbulent economic times, bonds are often seen as a haven; however, bonds can be quite risky in periods of market volatility. This is because interest rates can become uncompetitive compared to other forms of investments. Inflation can outpace the yields offered by bonds, and deflation may lead to decreased principal values.
These factors demonstrate that while bonds usually offer security and stability when markets are stable, they cannot guarantee this same level of protection when conditions become more uncertain. Investors may want to investigate alternative options, which do not depend on the stock market while still generating returns.
This is where insurance products have come into focus as people look for alternative investments to diversify their retirement portfolios and protect their money during economic and stock market volatility.
The Advantages Of FIAs
FIAs pique interest due to their feature of earning interest rates tied to the performance of market indices such as the S&P 500, while avoiding direct investment or market exposure. By combining elements from various annuity types, FIAs offer the advantages of fixed annuities, providing protection, and index annuities, offering growth potential.
During the global financial crisis of 2008, FIAs emerged as a safe haven for investors. As stock markets plummeted and traditional investment vehicles faltered, individuals who had allocated a portion of their portfolio to FIAs found themselves in a more secure position.
For investors who owned annuities prior to the 2008-09 downturn, their annuity contracts protected the principal invested in their annuity. Meanwhile, the S&P 500 lost 46% of its value from October 2007 through March 2009.
FIAs often deliver 100% principal protection based on the contract between the annuity owner and the issuer. There is a 100% financial reserve requirement of FIAs by insurance commissioners nationwide. Conversely, the FDIC financial reserve requirement of U.S. banks for bank certificate of deposit investments is between 3% and 10%. In my experience, I have found that many investors are more comfortable with a 100% financial reserve requirement product.
FIAs have a hybrid investment structure where the principal is invested into 10-year U.S. Treasury bonds that have been widely considered a safe investment compared to higher-paying U.S. corporate bonds, which have default risk. Treasury bonds are also not exposed to financial market risk. The interest generated from the investment in the 10-year Treasury bond with each FIA is invested into options of the market-linked index associated with the individual annuity.
Pre-retirees and retirees eventually enter into a deaccumulation phase to generate income during their retirement years. FIAs and annuities in general are insurance against outliving their money and becoming dependent on their children, and provisions to deliver income for the annuity owner’s life and, in many cases, their spouse. This can be an attractive feature that will give annuity owners important income to satisfy their living expense needs.
Income generated from an FIA can also eliminate the need to withdraw funds from more traditional retirement and other investment accounts.
Additionally, in strained economic climates, diversification can be helpful. By diversifying across different asset classes such as fixed-income instruments and alternative investments such as private equity funds, investors can mitigate their exposure to market risk while still achieving returns.
The Flipside
With all the potential positives of an FIA investment, it is wise to also consider the possible downsides including:
• Liquidity. Most fixed indexed annuities have surrender charges that decrease over time. Most annuities allow up to a 10% penalty-free withdrawal of the principal or premium invested. Because you likely would only have access to 10% of the money you invested into a fixed indexed annuity, you would want to make sure you wouldn’t need more than that before you invest into an annuity.
• Caps. An annuity company may give you a large portion of the gains generated by the underlying index, but it may also limit the total upside of the growth generated from the index with a cap.
• Fees. A fee is charged each year and can make it more difficult for the annuity to perform and grow the account and income values.
Additionally, because of its long-term investment benefit structure, an FIA may not be a good fit for your situation if you need immediate access to a significant portion of your principal investment.
Market Volatility Doesn’t Have To Mean Financial Loss
Taking time to understand the risks associated with the stock market and diversifying investments across different asset classes to protect money and get returns without taking on too much market risk is critical in today’s economic landscape. Though many people feel the worst is still yet to come, investors feel secure knowing they have options to protect their money despite current market conditions.
With our current market likely heading toward even more economic turmoil, it’s more important now than ever to rethink how you are protecting your money.
Investment advisory services offered through Brookstone Capital Management, LLC (BCM), a registered investment advisor. BCM and Active Wealth Management, Inc., are independent of each other. Insurance products and services are not offered through BCM but are offered and sold through individually licensed and appointed agents.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
Ford Stokes is the President of Active Wealth Mgmt and Host of The Active Wealth Show.
