As many of our retired clients know, there are a number of pieces to the retirement puzzle. For those of you who have gone through our developed and refined process during the last 5-7 years, we have been a big believer in adding a fixed-indexed annuity (FIA) to a retirees’ portfolio as a proxy for bond funds. Given the low interest rate environment we’ve been in for a sustained period, the FIA has added upside potential while removing the interest rate risk associated with bonds.
As Wendy referenced in her article, “Understanding a Fixed Index Annuity,” you can never lose principal or prior year earnings within a fixed or indexed annuity contract. The worst-case scenario is you earn nothing over a 12-month period if the indices you are participating in have a down year. (Please click the link above if you would like an FIA refresher.)
Given our current inflationary concerns, the Federal Reserve’s scheduled rise in interest rates, and the overseas Russia-Ukraine conflict, markets have been volatile to say the least. As indices across the globe have suffered through the 1st quarter of 2022, many FIA’s with recent contract anniversaries have had a zero-return year.
“I made nothing on my annuity over a 12-month period, Aaron. How is there value in that?”
Traditionally, retirees comprise a portfolio of 60% equities and 40% fixed income. Perhaps it’s 50/50. Maybe it’s 40/60. How someone feels about market risk will determine how much volatility is in the portfolio. While you’re working, you’ve never had to worry about taking money out of your portfolio to live on because your paycheck was consistent and reliable. Now, investment portfolios, pensions and Social Security must replace your paycheck and stay just as consistent and reliable for an indefinite time period.
More conservative investors generally utilize bonds and bond funds for risk reduction, but especially flock to these tools in tumultuous times. Bonds are perceived as “safe” – unfortunately, bonds have an inverse relationship with interest rates. As rates rise, bond values fall. Where do we think rates are headed in the future? Up.
As of March 7, 2022, the Barclays US Treasury 10-year bond index is down 4.80% since January 1st. If that is supposed to be an investor’s safe haven for reliable income, the volatility is much too high for a “safe” investment. The S&P 500 is down 11.86% year-to-date. Where do you draw retirement income from when the market is down? The alternative to a bond fund is the FIA.
Knowing that the worst-case outcome over a 365-day period is 0% earnings, but 0% losses – you are effectively creating a new “asset class” that provides downside protection in volatile market environments. You have now eliminated the worry of having to deplete a securities portfolio and recognize the loss when the market is down.
To answer the question more directly – if my investment account is down 10-15%, my 0% return annuity is now my best performing investment because I haven’t lost anything on those dollars. It provides the retirement plan a new spicket of income for the retiree to draw on without compounding the market losses with distributions. That is the biggest value-add an FIA can provide – it creates time for your securities portfolio to recover from short-term underperformance.
If you are a younger investor in your 20’s, 30’s or even 40’s, a 0% return year doesn’t have a ton of value. In retirement, a 0% return FIA provides a tremendous amount of protection and coverage in our current interest rate environment and during the continuing expected upward trend.
The bull market run from post-2008 until now has been the best in history. No-one likes talking about downside protection and mitigating volatility in the portfolio when markets are rising how they have been for years on end. However, Covid-19 and the trickling effect it has had on the U.S. economy has started to show its teeth.
Remember, holding an FIA as a piece of your overall investment strategy allows you to hold less bond funds inside your securities portfolio, adding to the long-term upside potential of that investment account. The FIA is for sustainable income and retirement withdrawals, especially in volatile environments. The value-add of a 0% return is knowing you have a reliable source of funds to live on, regardless of who is at war or when interest rates are rising in the future.
In one sentence, a 0% worst-case scenario provides insulation.