Annuities and the Stock Market
The Annuity Man
We are currently experiencing some of the most volatile days the stock market has ever seen. That is an understatement when you are now seeing daily market moves that used to take a year to accomplish. In addition to the most important topic being our health and safety, people are also reevaluating their investment holdings and inherent risks with the stock market.
The stock market vs. annuity discussion is a good one to have knowing that there are no perfect answers, just bad sales pitches. It’s not a good vs. evil comparison as much as it is apples vs. oranges...in my opinion.
Most people are not aware that the majority of stock market trades are performed by non-humans. Black box, high velocity, algorithmic, and institutional computerized trading systems dominate daily volume. I tell my clients that investing in the stock market and competing with the “big boys” is like surfing beside a cruise ship. You might catch a wave now and then, but you will eventually get sucked under the boat. Most Americans are currently experiencing what being “sucked under the stock market boat” really feels like.
The public relations messaging around the stock market has been brilliant. Hang in there for the long term. Don’t sell. Don’t panic. Historical returns always win out. Act like Warren Buffett and buy quality. All of those overly repeated catch phrases are true in context, but mean absolutely nothing when you see your retirement nest egg going in the toilet.
It also doesn’t help things when you read about a hedge fund “genius” who goes on TV and scares the world with his honest assessment of current volatility, and then we learn they made $2.6 Billion (yes...Billion with a “B”) in less than a month trading this volatile market.
Those stock market PR firms better be very careful right now because that “buy and hold” directive to the masses might not work after we get past this current pandemic.
Hating Principal Protection
Are annuities better than stocks? No. Stocks aren’t better than annuities either, regardless of what the “hate annuities” ads or your myopic advisor tells you.
Annuities are transfer of risk contracts that are issued by life insurance companies. They primarily solve for income or principal protection, even though annuity agents and advisors don’t typically focus on those contractually low commission type products. So when I’m asked “Is an annuity a good investment?”, my answer is that annuities are not investments, they are contracts. Don’t believe me, then ask someone who bought an annuity what they received in the mail. They were delivered a policy (i.e. contract).
Annuities are the only financial product that guarantees a lifetime income stream. It’s a monopoly that only annuities can provide. Your Social Security payments are an annuity guarantee for life. So are your pension payments, if you are one of the few people that still receive those.
Annuities can also provide full principal protection with products like Multi-Year Guarantee Annuities (MYGAs), which is the annuity industry’s version of a CD.
During times of severe volatility in the stock market, there’s not many people who will say they hate principal protection. I’m assuming that you would be OK right now with a little more principal protection.
Not For All
I’m the first person to say that annuities are not for everyone. If you are not looking to place a lump sum toward a guaranteed rate of interest or a lifetime income stream, then you do not need an annuity. In my contractual guarantees only annuity world, these strategies solve for 4 primary things. The acronym I use for people to easily remember these contractual goals is P.I.L.L.
P stands for Principal Protection
I stands for Income for Life
L stands for Legacy (i.e death benefits)
L stands for Long Term Care/Confinement Care
If you do not need to contractually solve for one or more items in the P.I.L.L., then you don’t need an annuity of any type. Period.
Apples and Oranges
If you want stock market type growth, then do not buy an annuity. There is no specific type of annuity that can provide those consistent returns. Variable Annuities (VAs) use mutual funds (aka: separate accounts) as their “potential” sales hook, but your choices are limited and the load VA fees (i.e. annual expenses) are typically very high.
Fixed Index Annuities (FIAs) are fixed life insurance products that were designed to produce CD type returns. Unfortunately, FIAs are the poster child for “square peg into round hole” sales pitch tactics. FIAs used to be called Equity Indexed Annuities, and “Market upside with no downside” is the catch phrase you will hear at the bad chicken dinner seminar. However, that dream pitch is not the contractual reality.
Don’t be fooled by back-tested proposals that are not guaranteed and attached to a FIA with long surrender charges and high agent commissions. The non-guaranteed FIA returns are typically based on a one year call option on the S&P 500 (not including dividends), with severe contractual limitations on the upside.
The bottom line is that no annuity type can compete with historical stock market returns. If that is what you want, and you can handle the volatility, then never buy an annuity.
Transfer or Shoulder Risk
Annuities and the stock market “argument” comes down to one thing. Do you want to shoulder the risk, or do you want to transfer it? Age has nothing to do with it in my opinion. If you are OK with risk and in a perpetual accumulation phase, then stay in the stock market, ride it out, and trade away.
If you have made the decision that you want to transfer some or all of that risk, then a specific annuity type might fit into your retirement plan. Whether you want a guaranteed minimum interest rate with principal protection or a guaranteed income stream that you can never outlive, transferring risk to a fixed annuity makes contractual sense.
To make a more timely correlation, consider social distancing yourself from market risk and volatility. My apologies for that. Couldn’t help myself.