Fixed Index Annuities - better than bonds?

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CULater
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Fixed Index Annuities - better than bonds?

Post by CULater »

Mark Hulbert has recently written that Fixed Index Annuities (FIAs) may now have become preferable to bonds in retirement portfolios. Higher yields over time than bonds with no downside risk. FIAs are sold by brokers and they guarantee a capped return (such as 50% of the index) on the stock market index with no risk of loss if stocks decline in price. In ordinary times, these are a Boglehead non-starter. But in these times, they might deserve a second look for retirees who are looking for better returns over the long term than you can get from bonds with even more protection from losses than bond funds offer. With FIAs you run the risk of zero return when stocks decline, but with the guarantee you won't lose anything if that happens. With bonds nowadays, you run the risk of very low or even negative interest rates and the risk of loss of principal if rates go up. What do you think?

https://www.marketwatch.com/story/how-t ... latestnews
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Re: Fixed Index Annuities - better than bonds?

Post by Jack FFR1846 »

I'll say several things.

I track my investments almost every single day. My bond funds have been skyrocketing! Why would I want something different?

I forget. Is Mark the "Annuity Guy"?

When this newsletter salesman says that you get the upside of the S&P 500 with a cap and limited or no downside, does he actually mean that you get only a portion of the upside of the S & P WITHOUT DIVIDENDS with little or no downside?

I have learned to take a step back. If these instruments were so good for us, why would an insurance company, who absolutely is going to make a profit on these give me some kind of good deal? From my stepped back position, I have to answer to myself that there's no good deal to be had. By limiting risk, I don't get all of the gain of the index, I get no dividends and I pay big fees and commissions all the time.

Nope.
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David Jay
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Re: Fixed Index Annuities - better than bonds?

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I think the root flaw in the article is that the article is comparing an FIA to the bond component of an individual's portfolio in isolation. And yet any growth in the FIA is tied to a STOCK index. An FIA provides no diversification (away from stocks) whatsoever. Without market growth there is no growth in either the stock portion or the "fixed income" (broadly defined to include the FIA annuity) portion of the portfolio.
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Re: Fixed Index Annuities - better than bonds?

Post by David Jay »

From the article, on participation rates: "Now those rates are closer to 30%." :shock:

And that is 30% of the index, not the total return.

So at today's participation rates (and perhaps 1% in fees) an FIA will almost certainly under-perform a 20/80 portfolio.
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Re: Fixed Index Annuities - better than bonds?

Post by nisiprius »

Recall Betteridge's Law of Headlines: "Any headline that ends in a question mark can be answered by the word no."

Mark Hulbert says fixed index annuities provide a way
to tiptoe back into equities without incurring any downside risk
But FINRA says
Is It Possible to Lose Money In an EIA?
Yes.
As far as I'm concerned, that disqualifies Hulbert's article.

To be sure, the article is sufficiently full of hedging and on-the-one-hand-on-the-other-hand that he has left himself an out, while FINRA's comments of situations in which you could lose money only apply to "many" fixed index annuities.

Notice, too, the tenor of Ibbotson's comments quoted by Hulbert. A year ago fixed indexed annuities were better than bonds because interest rates couldn't go down. They went down. Now Ibbotson says that fixed indexed annuities are better than bonds because interest rates are down.
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Re: Fixed Index Annuities - better than bonds?

Post by Nate79 »

Have the insurance snakes found another way to spin these horribly complex and expensive products? Did the product name change from equity to fixed not do enough to trick the consumers into buying this product?
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Re: Fixed Index Annuities - better than bonds?

Post by garlandwhizzer »

I believe it to be another sale of pseudo-safety to anxious investors at a high price. Designed to be sold, not bought.

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Re: Fixed Index Annuities - better than bonds?

Post by willthrill81 »

I'm going to go out on a limb and say that buying puts to limit one's downside risk with stock would be a lot cheaper than doing the same thing through an insurance company. Stop-losses would do the same thing and don't require that the investor buy anything.

I'm not recommending either of these approaches, but both would seem preferable to a FIA to me.
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Re: Fixed Index Annuities - better than bonds?

Post by Mel Lindauer »

Here's a Forbes column I did on these awful things back when they were called Equity Indexed Annuities. Their reputation got so tainted, they changed the name to Fixed Index Annuities. Still the same animal.

https://www.forbes.com/2010/08/10/truth ... 1b5ba12573
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Re: Fixed Index Annuities - better than bonds?

Post by CULater »

Mel Lindauer wrote: Wed Apr 22, 2020 2:53 pm Here's a Forbes column I did on these awful things back when they were called Equity Indexed Annuities. Their reputation got so tainted, they changed the name to Fixed Index Annuities. Still the same animal.

https://www.forbes.com/2010/08/10/truth ... 1b5ba12573
Thanks, Mel. Still looks like a non-starter.
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Re: Fixed Index Annuities - better than bonds?

Post by patrick »

Bond yields today are indeed very low, and thus expected bond returns are also very low. However, it is not so obvious what to do about this.

Presumably the index annuities were priced to provide the insurance company a profit after all their costs, including sales commissions, regardless of market returns. Interest rates today are lower than many people though possible -- perhaps lower than insurance companies though possible. If the annuity rates haven't been fully adjusted for today's shockingly low bond yields, they just might be a reasonable deal.

I looked at a few indexed annuity offerings that came up from a quick web search, finding the following:

Most annuities sold today seem to have a complete guarantee against downside risk, provided that you hold until the end of the surrender period. This is only a nominal guarantee -- they don't guarantee keeping up with inflation.

While the article talks focuses on participation rates, caps seem more popular. Many annuities use a bizarre system where the cap is monthly but the floor is annual. If I understand correctly, 6 months of 20% monthly gains followed by 6 months of 10% monthly losses would give a 0% annual return -- the caps turn 20% monthly gains into 2% monthly gains, while the monthly losses stay at 10%, resulting in an annual loss pre-floor, and 0% post-floor.

Among annuities using simpler annual caps, the best S&P 500 annuity I saw in my brief search had a 4.75% cap. It would be rare for the annual price return to fall within the 0% to 4.75% range, so in most years would hit either the 4.75% cap or the 0% floor. With up years more common than down years, perhaps the annual expected return should be 3% or so.

Series EE savings bonds double if held 20 years (3.53% per year) and have better tax treatment, so if you are sure to hold the investment a long time (a virtual necessity for annuities given their surrender chargers and tax penalties for early withdrawal), the annuity is clearly worse than the EE savings bond. If you had already purchased the EE bond limit, then the annuity looks decent at first glance, but ...

The fine print allows the insurance company to lower the cap! There is a minimum cap they can't go below, but while it was easy to find the current cap, I couldn't easily find the minimum cap. Apparently I have to call the annuity company to find out!
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Re: Fixed Index Annuities - better than bonds?

Post by willthrill81 »

patrick wrote: Wed Apr 22, 2020 4:53 pm Bond yields today are indeed very low, and thus expected bond returns are also very low. However, it is not so obvious what to do about this.
Sure it is. People just don't like doing it.

Accumulate more assets.
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Re: Fixed Index Annuities - better than bonds?

Post by BeachPerson »

Fidelity on Index Annuities

Fidelity did a nice job explaining them The participation rate is also scary.

I will avoid like the plague
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Re: Fixed Index Annuities - better than bonds?

Post by Nate79 »

I recall that it is even worse that the insurance company can change the underlying costs such that they make out in the end. Truly a huge stinking pile.
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Re: Fixed Index Annuities - better than bonds?

Post by David Jay »

Nate79 wrote: Wed Apr 22, 2020 7:18 pm I recall that it is even worse that the insurance company can change the underlying costs such that they make out in the end. Truly a huge stinking pile.
From the FINRA warning (link in Nisiprius’ post):
Caution! Some EIAs allow the insurance company to change participation rates, cap rates, or spread/asset/margin fees either annually or at the start of the next contract term. If an insurance company subsequently lowers the participation rate or cap rate or increases the spread/ asset/margin fees, this could adversely affect your return. Read your contract carefully to see if it allows the insurance company to change these features.
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Re: Fixed Index Annuities - better than bonds?

Post by Nate79 »

David Jay wrote: Wed Apr 22, 2020 7:34 pm
Nate79 wrote: Wed Apr 22, 2020 7:18 pm I recall that it is even worse that the insurance company can change the underlying costs such that they make out in the end. Truly a huge stinking pile.
From the FINRA warning (link in Nisiprius’ post):
Caution! Some EIAs allow the insurance company to change participation rates, cap rates, or spread/asset/margin fees either annually or at the start of the next contract term. If an insurance company subsequently lowers the participation rate or cap rate or increases the spread/ asset/margin fees, this could adversely affect your return. Read your contract carefully to see if it allows the insurance company to change these features.
It really should be criminal what they get away with.
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Re: Fixed Index Annuities - better than bonds?

Post by Mel Lindauer »

Nate79 wrote: Wed Apr 22, 2020 8:02 pm
David Jay wrote: Wed Apr 22, 2020 7:34 pm
Nate79 wrote: Wed Apr 22, 2020 7:18 pm I recall that it is even worse that the insurance company can change the underlying costs such that they make out in the end. Truly a huge stinking pile.
From the FINRA warning (link in Nisiprius’ post):
Caution! Some EIAs allow the insurance company to change participation rates, cap rates, or spread/asset/margin fees either annually or at the start of the next contract term. If an insurance company subsequently lowers the participation rate or cap rate or increases the spread/ asset/margin fees, this could adversely affect your return. Read your contract carefully to see if it allows the insurance company to change these features.
It really should be criminal what they get away with.
They get away with it because folks don't read the (often) 100+ pages of fine print that give the insurance company everything while the salesperson only mentions the feely-good stuff that the fish on the line will supposedly get.

A simple rule of thumb: Don't mix insurance and investing. Period.
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Re: Fixed Index Annuities - better than bonds?

Post by willthrill81 »

Mel Lindauer wrote: Wed Apr 22, 2020 10:16 pm A simple rule of thumb: Don't mix insurance and investing. Period.
+1000

This should be one of the principles in the Boglehead philosophy.
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Re: Fixed Index Annuities - better than bonds?

Post by Stinky »

David Jay wrote: Wed Apr 22, 2020 7:34 pm
Nate79 wrote: Wed Apr 22, 2020 7:18 pm I recall that it is even worse that the insurance company can change the underlying costs such that they make out in the end. Truly a huge stinking pile.
From the FINRA warning (link in Nisiprius’ post):
Caution! The overwhelming majority, if not all, of Some EIAs allow the insurance company to change participation rates, cap rates, or spread/asset/margin fees either annually or at the start of the next contract term. If an insurance company subsequently lowers the participation rate or cap rate or increases the spread/ asset/margin fees, this could adversely affect your return. Read your contract carefully to see if it allows the insurance company to change these features.
I've corrected the FINRA warning above to what I think is the real world situation.

I didn't say that "all" EIAs allow the insurance company to change participation rates because there might be a contract out there that doesn't have that feature. However, I believe that an insurance company would be insane to indefinitely guarantee a cap rate or a participation rate, and that the pricing team that made such a horrendous blunder would be fired.
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