Managing Volatility

Volatility Is Not A Four-Letter Word

At 20 years old, Indexed Annuities make just as much financial sense now

by Mike Janky, CLU, ChFC, CFS, RHU, CAS, CASL, RICP
Mr. Janky, a Registered Investment Advisor, is President of Forward Strategies Insurance Brokerage,LLC., a national wholesaler for annuities, life insurance, long-term care, and hybrid products including case design, lead program creation, and referral systems. Visit fsib2000.com

The stock market in 2016 has started the year with the dubious honor of being one of the worst and most volatile calendar year beginnings in the history of the market.

We are seeing swings as much as 3% each day and that can be a pretty harrowing experience for someone that has just retired or is thinking about retiring. As of the writing of this article, the S&P 500 Index is down about 10% for the year.
With oil prices continuing to plummet and looking for a bottom and the challenges in China and Europe with their economies, many financial experts are predicting that 2016 is the year the markets have that big correction that has been in the back of our minds for the past several years.

With all the gloom and doom press right now, what is a person that is trying to get a reasonable return on their money supposed to do? With the modest increase in interest rates that the Fed announced at the end of 2015, the banks have had little reason to raise the crediting rates on their savings and money markets accounts.

Many people are frustrated and looking to find a place that they can actually make their money grow without having to subject their accounts to the inherent risk that comes with being in the market. Well the good news in all of this is that there is an option that can take advantage of volatility and give them some upside potential without having to risk their principal. This option has been around now for over 20 years and continues to be an excellent option for many people trying to protect their assets.

Indexed Annuities-Using Volatility as a Positive

Back in the spring of 1995, two insurance companies introduced the first indexed annuities offered to United States savers on a national scale.
This new annuity concept was viewed with a fair amount of skepticism. Why would someone want to give up part of the upside to protect their principal when pretty much every stock and growth mutual fund was enjoying double-digit returns in most years of the 90’s decade? If you weren’t making 20% returns, you were unhappy.

Well what those first indexed annuities offered back then continues to be the true benefits of products today; part of the upside and none of the downside.There are hundreds of different indexed annuities available today to the consumer. You have different indexing strategies, different indexes being used and new indexes created and different guarantees offered on these products. Having used these for my own personal clients for nearly 20 years, I can tell you that there are some good products and some not-so-good products available on the market today.

Giving clients what they want

So with so many options out there, what should one look for? As with any type of investment or insurance product, I believe it comes down to what are the most important benefits to the client. Is it having the best upside potential? Is it having the best minimum guarantees? Could the top priority be what is the best guaranteed income I can generate guaranteed for life?

As with all products, there are strengths and weaknesses that each and every one has. The key is to match up the best features and benefits specific to the individual. If you are looking for the best growth potential, then one of the key features on the indexed annuity you select for your client is going to be having an uncapped indexing strategy you can select as one of the options inside the policy.

With the volatility that comes with the market, you need to have an option that will allow you to capture a good percentage of the increase in the index in years where the market does very well. If you go back to January 1st, 2000, the S&P 500 was at 1,394. As of February 11, 2016 the S&P 500 closed at 1,829. That equates to about a 32% return or a little over 2% annual return for 15 plus years.

What these indexed annuities won’t do is capture all the gains in the market each and every year which in my opinion is a reasonable concession

What you may find interesting is that there were seven calendar years during that time frame where the S&P 500 was up over double-digits and out of those seven years, four of those years had increased 19% or more. If you were locking in gains of even half of those returns, you would have done very well compared to actually being in the market and would have taken zero risk to your principal to boot!

The whole concept of indexed annuities is that you capture a percentage of those gains in positive years and you don’t’ give back any gains in negative years. If you have an indexing strategy that allows you to capture a percentage of those gains without a cap on the gains, your overall return is going to typically be better than a strategy that gives you all the gains up to a cap of 3 to 4%.

Over the last few years, the insurance companies have been able to design annuities that provide higher participation rates using strategies such as charging an annual fee for the better upside potential or using volatility controlled indexes that by creating less volatility in the indexes, allows for higher participation rates with no cap.

These changes have allowed the insurance companies to offer their policy holders good upside potential in spite of the low current interest rate environment that they are having to deal with on their own investments. Keep in mind that all insurance companies are still guaranteeing the contract holder that their principal is safe and will be there when they need it.

Keeping things in perspective

When recommending these indexed annuities, it is important to understand what they will and won’t do. These products will provide some good upside potential and if the indexes perform, they will share in a percentage of those increases.

The primary goal of an indexed annuity is to get a better overall interest rate credited than what one could receive from another safe-money option such as a savings or money market account or a traditional fixed annuity. What these indexed annuities won’t do is capture all the gains in the market each and every year which in my opinion is a reasonable concession.

Another thing these annuities won’t do is put at risk the policyholders’ principal or previously credited interest. When a person retires and their income is based on their social security, pensions and what they have amassed in assets over their working years, it’s the most important time of their lives to protect what assets they have and to also protect their standard of living.

No one wants to see their portfolios decreasing and then have to make some hard decisions such as can we afford to continue to gift to our kids, take the planned vacation this year or ultimately, do we have to change our way of life due to the losses in the market. Not having the ability to replace losses in the market with earned income from working makes these decisions paramount.

When protecting a clients’ assets using indexed annuities, you are providing them a foundation to build upon.

Asset location Strategy

If someone wants to continue to be invested in the market, they can use some of their assets to be aggressive while they know that the money they have in their annuities is safe and guaranteed.

It truly puts them in a win-win situation. If the market does go up, they will still earn a good overall return. If the market tanks, they will not watch all their assets decrease. As we all nervously watch 2016 unfold, there will most likely continue to be some big swings both up and down in the market. For those that don’t have the stomach for this, the indexed annuity option provides a much smoother ride.

Warren Buffett, probably regarded as one of the best investors of all time once said “Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market.” Based on this quote, how many retired people should be in the market and how many would benefit from an indexed annuity? ◊