Put an “Annuity Egg” in Your Basket

With the stock market just finishing one of its most abysmal decades ever, it’s natural for investors to reconsider their estimates for the future. 

As boomers age, they face one of the greatest challenges in their lives: how to avoid running out of money in retirement.

It may be too late for retirement investors to recoup losses incurred since the last time the market peaked. 

Due to advances in medicine and healthcare, people can expect to live longer after retirement which adds the problem of “Longevity Risk” which is the risk of outliving your savings.  Many boomers are financially unprepared for retirement and may go broke.

The ups and downs of today’s stock market are dizzying, and this therefore makes it inevitable for you to consider diversifying your investment portfolio.

In decades past, many employers offered pension plans that would provide income in retirement years, few companies now provide such benefits beyond 401K contributions, matching employee contributions and perhaps a percentage more as added incentive. However, since the stock market downturn in October 2007, many 401(k) plans are still down 25 percent from the peak, leaving boomers with less money to draw from. 

What’s more, employers in many fields are making it harder to save enough money to retire.

Here are total retirement contributions in 2008 as a percentage of pay in the eight industries surveyed and the amount they have declined (or increased) since 1998:

• Retail and wholesale, 3.82 percent, down 33 percent.
• Manufacturing, 6.35 percent, down 29 percent.
• Energy, natural resources, gas and electric, 9.23 percent, down 24 percent.
• Pharmaceuticals, 9.27 percent, down 13 percent.
• High tech, 5.24 percent, down 10 percent.
• Financial services, 8.28 percent, down 9 percent.
• Health care, 6.1 percent, down 4 percent.
• Services, 4.3 percent, up 3 percent.

Most of the decline was because companies switched from traditional pensions to 401(k)s and other types of defined contribution plans. Also, the financial crisis in 2007 encouraged companies to contribute even less.

Today, retirement planning has taken on a new urgency and even greater importance with uncertain and volatile economic conditions. The markets stomach-churning swings are testing the nerves of boomer investors.

Many people have seen their 401K savings that they have built over many years crushed by market losses of late, delaying retirement or destroying retirement dreams completely. Those investing for or in retirement should think about protecting what they have amassed. “You want to avoid speculation and Risk….

Once a dependable investment, home value equities have suffered dramatic reductions. Additionally, there are uncertainties about the continued benefits to be paid by Social Security and the age of qualification.

Most portfolios have some allocation to bonds and for people who are closer to retirement or in retirement, however there are risks of investing in bond funds.  As interest rates rise, the values of bonds decline.  If you are holding individual bonds, you can wait it out until the bond matures and then get your principal back. But if you are in a bond fund, the bonds don’t mature and the value can drop.

Exposure to stocks is too great as retirement approaches and not reallocating to safety and security in a timely manner. About 1 in 3 investors approaching retirement age had more than 80 percent of their account balances in the wrong asset allocation according to a report completed in 2008. Exposure to unseen market trends which are out of most people’s control can result in poor performance just as retirement approaches.

Striking an appropriate balance between risk and reward is critical. It is therefore not advisable to put all your eggs in one basket: Some people put all their investment money in one or two schemes or plans without allowing for hedging by diversification. Such a strategy is flawed and very sub optimal as it exposes your investments to unnecessary risks.

Is this a good time to invest in the stock market?  Projections of past performance is based on past history that goes as far back to the 1800’s – and that makes no sense at all.  Experts are suggesting that a 5% growth is closer to what has actually occurred and most of that came from inflation.  In 1969 the US gross domestic product was about $1 Trillion and the Dow Jones Industrial Averages was at 1000.  Thirteen years later, the US economy had grown to $3.3 Trillion.  The Dow?  About 1000. Still want to invest in Stocks?

Index funds are funds that fluctuate in accordance with the market they’re based on. Because of the breadth and diversity of the equities included, many investors and others look to the Standard & Poor’s Index of 500 Stocks (S&P500) as a reliable barometer on the state of the US economy, and many also invest in funds based on the index’s performance.

Index funds exactly mirror the performance of the index they’re based on. Investors in an S&P 500 fund feel that they can expect positive returns over the long run based more or less on the performance of the American economy as a whole.

However, at the end of 1999, the S&P 500 was at $1,469.25. It then recorded three straight losses, followed by a string of gains that brought it virtually to a break-even point at the end of 2007. There was another disastrous decline in 2008, though, so that at the end of ten years (12/31/2009), the value of the index was $1,115.10, fully 24.10% below its value on 12/31/1999. 

Mutual funds are called many things, index funds, exchange traded, balanced funds, diversified equity funds “large cap value, small-cap growth, mid cap blend, international small-cap value, and debt funds are just few in the long list. These are marketing gimmicks.  These funds are typically 100% invested all the time, and all in stocks. Are you sure you want to invest in this kind of investment?

Additionally, fund managers are typically paid an annual fee that is a small percentage of your invest pool. This fee usually ranges from one to two percent. This comes right off the top or your investment.  Add inflation and you will be losing money even when your fund is making money. Secondly, many times you have to pay income taxes on the reported gains on sold funds, again even if you have lost money in the fund.

How about and investment that deliver real returns? Develop an income-demanding mindset. Savvy investors will already have recognized, though, that this is no hypothetical scenario.

Annuities are the only financial product available which can provide income for any time period, even lifetime. “Not” using these products can adversely affect the need for income over long period of time.  This is a serious elimination of the Longevity Risk of living past your savings.

These of course are not the only types of investments you can make for your golden years and it never hurts to have more eggs in many baskets, however, this can be the most important egg that protects your future.

Indexed annuities are currently one of the safest ways for a retiree to allocate their money to make sure they have retirement income.  With their guaranteed payouts and protection against market downturns, annuities have long enjoyed a reputation as a refuge in times of turmoil.

Equity indexed annuities are relatively new products to the market and offer the best of all world’s to the investor. These retirement annuities increase in value when the market rises but they don’t lose money if the market drops. Instead, they receive a fixed interest rate promised in the contract. While not all equity indexed annuities are ties to the same type of index, many use the S&P 500 as their benchmark.

A fixed indexed annuity, that is tied to a market index, should come with a guarantee that you will never lose money too. In up years, your gain may be somewhat less than the market’s growth, but in down years, your gain should be fixed to 2 or 3 percent growth. The potential of gain, while still eliminating the risk of loss, is one reason that annuities are popular ways to plan for retirement.

How Fixed Index Annuities Differ from Index Funds

What FIAs do is remove the power of loss from the earnings equation. When the underlying index loses value, the FIA’s value remains steady. When the index gains value, the FIA also increases. Thus, over two years, the index could lose value in the first year and gain in the second. In index fund would mirror the index’s performance, but the FIA would only gain.

Likewise, if the index gains in the first year but loses in the second, the index fund’s performance would be identical, but the FIA would retain all the gains of the first year and “sit out” the losses of the second. This is the ratchet and reset concept – once gains are posted to an FIA, they’re locked in. The principal value is increased by the amount of the gain, and future gains are calculated based on this new value.

The significance of these figures is this: those who purchased FIAs during most of this period gained, and in most cases their FIAs significantly outperformed not only the market, but all other funds: standard equity portfolios, index funds, mutual funds, even bond funds.

This is borne out by research originally undertaken to demonstrate that FIAs were bad investments over the long term; in fact, the farther back researchers went, the more definitively their hypothesis was refuted!

Index fund investors after ten years were still 25% below their initial investment, while those who’d purchased FIAs had almost doubled their money during the volatile first decade of the 21st century. This is what’s meant by the term “FIAs give you all the advantages of market participation with none of the downside risk!”

When it comes to the world of finance, many of us are far from experts. We seek legal advice from attorneys, tax advice from accountants, and medical advice from doctors yet very few of us go to financial planners when planning our financial retirement.  This might be the time to make an appointment with an annuity representative!