Stock Indexed Annuities: A Powerful Investment For Getting Back to Even

by Dr. Mark Skousen, Advisory Panelist, Investment U
Friday, December 04, 2008: Issue #896

How long does it take your portfolio to recover after a devastating bear market?

It took a little over a year to get even after the stock market crash of October 19, 1987, over four years to get back your money after the treacherous 2000 to 2003 bear market, and more than five years after the 1973 to 1974 debacle.

This time around, with the Dow down 40% from its high of a year ago, it may take three to four years to get back to even. Ouch! If you are waiting for the new administration to bring you back to even, you may have a long wait.

But there’s a way to avoid this entire “catch up” worry: Buy stock indexed annuities. I call it “peace of mind” investing. My wife even has her IRA money invested in them. She hasn’t lost a single penny in her IRA this year because of her indexed annuities. And when the market does recover, she won’t miss out on its gains.

What Are Stock Indexed Annuities?

A stock indexed annuity is a tax-deferred annuity that combines the downside protection similar to a fixed annuity, money market or CD. But unlike these safe money investments, your interest earnings are calculated based on the performance of a stock market index such as the S&P 500, Nasdaq 100, or even European or Asian stock indexes. It enables you to profit from a market recovery.

Of course, you pay a price for eliminating your downside risk.

In exchange for the guarantee, equity indexed annuities typically pay slightly less than the full return of the S&P 500 Index. For example, an indexed annuity using “participation” might offer a “50% participation rate.” This means you’ll earn 50% of the increase of the selected stock market index. If the index is up 20% for the year and your participation is 50%, your return would be 10%.

But in the long run, the total return can be outstanding because in years the market drops, your capital is preserved. You are ahead of the game when the market moves back up.

Below is a hypothetical illustration showing how a stock indexed annuity would have performed compared to the S&P 500.

* S&P 500 return figures does not include dividends nor does the Stock Indexed Annuity.
**Indexed Annuity returns are calculated using monthly averaging, 100% participation, no cap, and a 2.95% spread.

As you can see, the stock indexed annuity would have averaged 8.39% while the S&P 500 only earned 4.40%. That’s mostly because in 2000 to 2002, thanks to the ability to lock in 100% of the gain, the indexed annuity didn’t lose a dime, while the S&P 500 Index got pounced, losing 21.47% in 2001 and 19.97% in 2002.

For over 12 years now I have been directing investors toward no-risk stock indexed annuities created by top insurance companies. Last time I recommended it was September 2007, near the top of the market. But they can be purchased regardless of where Wall Street is.

How Safe Are Stock Indexed Annuities?

One of the questions I often get is how safe are stock index annuities? And my first part of my answer is generally, “As safe as a life insurance policy.” My second answer is, “So make sure you’re investing with the right company.”

Today more than 50 companies offer stock indexed annuities with over 300 different products and dozens of ways to calculate your interest earnings. Make sure to stick with insurance companies that are rated highly by both AM Best and Weiss Services. (A good Weiss rating is vital – earlier this year AM Best rated AIG an A+ company; Weiss rated it a D.)

Most equity-indexed annuities are not registered with the SEC and are regulated under insurance laws. Annuities are backed by the state insurance reserve and multiple re-insurance companies.

So far no fixed or stock indexed annuities have defaulted on what is owed. (Fortunately, AIG was bailed out, so its annuities are safe.) Like any insurance product, it pays to do your research. A company’s history and longevity are some of the best benchmarks you can use.

Countless investors have been sacrificing returns for safety. But with stock indexed annuities, it’s a decision that they shouldn’t have to make.

Good investing,

Mark

Today’s Investment U Crib Sheet

Equity-indexed annuities are complicated products. You should know how they calculate their index-linked interest rate – before you buy. Or you could receive a lower return than the actual index’s gain.

Some of the terms used from these investments can be a little confusing as well. Here are a few of the basics terms you should know:

• Participation Rate: The participation rate determines how much of the index’s increase will be used to compute the index-linked interest rate. The higher your participation, the closer your return will equal the index’s.

 

• Interest Rate Caps: Some equity-indexed annuities set a maximum rate of interest that the equity-indexed annuity can earn. If an index does better than that cap, you don’t benefit. Lower rate caps limit your potential gains.

 

• Administrative Fee: The index-linked interest for some annuities is determined by subtracting a percentage from any gain in the index. Also called the margin, spread, or administrative fee. As with any managed investment, lower fees equal higher profits.

As with any investment, it pays to do your research, shop around and make informed decisions. Indexed annuities aren’t for everyone and if you are looking at them, you should consider all other investments opportunities out there as well.

With stocks getting hammered this year – the S&P 500 is down over 40% – there’s not a whole lot to get excited over with most indexes. Except one. The White Cap Index is up almost 135%. Get the next five stocks about to be added and learn more about the White Cap Report.

Related Articles:

• Value Investors – Beware The Value Traps
• Tax-Managing Your Investment Portfolio: There’s Still Time to Cut Your 2008 Taxes
• Variable Annuities: Beware These Promises of “Risk-Free Income”

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