Solving The Age-Old Risk Equation

The durable annuity portfolio continues to work

by Mike Janky

With interest rates starting to rise but still on the low end of the spectrum, people are trying to figure out where they can invest their money and have a chance for a decent return without having all their money at risk.

As people leave the workforce and begin their retirement years, one of the biggest challenges they face is finding a balance between risk and safety when investing. The greatest asset a person will ever have is the ability to earn an income. When someone is in their working years, it is much easier to take risk with their money as they can replace losses with earned income.

If a person is investing in their 401(k) every paycheck, the volatility in the market works to their advantage. When the market goes down, they will be purchasing more shares with the same dollars than when the market goes up. Also, they will have time on their side. When a person is in their 20’s, 30’s and 40’s, they can be in growth options with their investments and be reasonably confident that by the time they need the money for retirement, they should be rewarded for their ownership positions.

20 Year Look Back: The S&P Roller-Coaster

If we look at the S&P 500 index beginning on March 24th,2000, the index closed at 1,527.46 on that day. Fast forward to October 9th, 2002, the index was down to 776.76. This represents a 49% decrease over about a 31-month period.
Over the next 5 years, the index would climb back up to a high point of 1,561 on October 8th, 2007. Within 15 months from that date, the index would drop again, this time hitting a low point of 683.38 on March 2nd, 2009. This amounted to a decrease of 56%. During the next 4 years, the index would continue to increase and on March 25th, 2013, the index closed above the 1,561 mark.

From March of 2000, it would have taken about 13 years for the S&P 500 to get back to even. If a person retired in March of 2000 and was using the money invested in the index to generate income, they would have suffered some substantial losses along the way especially if they were taking a fixed dollar amount each month to supplement their retirement. Since 2013, the S&P 500 has had steady positive returns but also some sharp drops including the time between February 19th, 2020, and March 23rd, 2020, where the index dropped over a third. Beginning January 1st of 2022, the index is currently down approximately 5% for the year as of the time of authoring this article.

What Are The Options?

The old saying “don’t put all your eggs in one basket,” rings true when it comes to retirement and investing. Since people continue to retire at earlier ages than ever before and the average life expectancy is continuing to increase, there is a much greater chance of people outliving their money. Inflation over the last 6 months continues to rise at an alarming rate which will have a direct impact on the ability of retired people to continue their accustomed standard of living. So how does a person keep up or surpass inflation while protecting their assets? Using annuities as part of their asset allocation can be part of the answer.

Variable Annuities

Variable annuities can offer numerous investment options inside the contract. For instance, you can be in sub-accounts for domestic stocks, international stocks, emerging markets, etc. Most of the Variable Annuities offer many different choices from aggressive to conservative. They also allow the money to increase on a tax-deferred bases which can be beneficial for someone who is in their peak earning years and do not need the assets until later in retirement. The contract values of these types of annuities will move up and down as the investments inside the sub-accounts move up and down. Many investors, as they reach retirement, develop a more conservative stance and it becomes harder to watch the changes in value each day. I have always said people do not mind volatility, as long as it’s up!

Using Traditional Fixed Annuities

For those looking to reduce the risk of being in the market, the Fixed Annuity option may be a better choice. With fixed annuities, there are no decreases in the accounts. The client will earn whatever interest rate the insurance company is willing to pay for that specific policy.

The attraction to this type of contract is that no matter what the stock market is doing, they will never suffer a decrease in their account value. This is very comforting at retirement when the ability to make up losses with earned income is no longer viable. The challenge with the fixed annuities is that we are currently in a low interest rate environment. Current rates range from about 2-3.25% for a Multi-Year Guarantee rate annuity. Although this is still a much better option than keeping one’s money in the bank and earning extraordinarily little interest, 2 to 3% isn’t that exciting.

What About Indexed Annuities?

The third type of annuity that can be an option is known as an Indexed Annuity. With IA’s, there are numerous advantages for a person that has left the workforce and no longer feels comfortable taking a lot of risk with their entire nest egg. The Indexed annuities can offer better upside potential than other safe money alternatives such as Government Bonds, traditional Fixed Annuities, or bank accounts.

These products provide the peace of mind by not actually being in the stock market but having the returns linked to the market. Indexes such as the S&P 500, offer excellent upside potential. Many of the Insurance Companies have numerous indexes to choose from inside the policy, giving the policyholder different opportunities to earn interest.

Over the past couple of years in these products, there have been many that have enjoyed double-digit returns. Also keep in mind that once that interest is credited, it cannot be lost due to downturns in the market. I like to equate these products to being at the horse races except with a twist. If you bet on a horse to win and it does, you win the show money instead of the first place money.

However, if the horse finishes dead last, you get to use your losing ticket to go bet on a horse in the next race. The biggest knock on these types of products is that you do not receive all the upside potential. It is true that when the market goes straight up, you will not be getting the same kind of returns. With that said, when the market is tanking, you will not be losing any of your original principal OR any of the previous gains that were credited to your policy.

Also, when the market is going up and down as it did between the years 2000 and 2013, you will have years where you make money and years where you do not lose money. This can be an excellent option for a part of a person’s total assets especially when people are more concerned about the safety of their money verses trying to knock it out of the park.

Pools Of Money

By using several types of investments and insurance products, you can create a retirement plan that can provide safety along with the ability for growth. It does not have to be an all or nothing situation.

Many people like the idea of having part of their assets in guaranteed type of options. Besides giving them some peace of mind that their money will not disappear during retirement this can also allow them to be more aggressive with other parts of their assets. If a person is planning to use their assets to provide income at retirement, when the market is up, they can take some gains off the table in their more aggressive holdings while leaving the annuity value intact. This works just as well if not better when the market is down. Instead of needing to liquidate assets in a declining account, they can withdrawal money out of the annuity and allow more time for the depressed asset to recover.

Don’t Discount Your Value As A Planner

As a planner, you can help alleviate a lot of fears and nervousness that people will experience when entering the next phase of their lives after saying goodbye to the working world.

Most people have anxiety about retiring. Will I have enough money to do the things I want? What activities will fill my days? Will I spend or lose my money and need help from the Government, family, or friends? Will social security provide my main source of income and determine my standard of living?

The power you have as a planner to help navigate the uncharted waters for these people is enormous. Every situation is different, and every person has unique goals and fears not to mention dealing with different amounts and types of assets and total net worth. The more questions you ask and really understand each client, the better recommendations you will be able to make. Do not underestimate the worth you bring to the people you work with. You have the opportunity and ability to be their most valuable person when it comes to retirement!