If you've listened to the radio for more than about 10 minutes lately, you've likely been hearing ads for “can’t lose” investments that promise you will benefit from raises in the stock market with no risk of losing your principal, even if the markets tank. While the commercials rarely so say, they are promoting annuities – more specifically “indexed annuities”.
At first glance, an indexed annuity seems pretty attractive. You purchase the annuity from a big name insurance company, which promises to return your principal to you “regardless of how the stock or bond market does”. The catch (or at least one of the catches) -- there’s usually a 10 to 15 year period of time where your money is locked up – and if you want to pull it out of the annuity, big surrender penalties can apply.
Nothing but upside, right? Well, sorta.
From the indexed annuities I’ve seen and studied, the financial upside is very limited. Based on the market’s performance over the past 25 years, annuity owners were doing very well if they earned a 2.5 percent per annum return. Remember, the insurance companies are only giving you small fraction of what the market they are tracking actually returns (these are referred to as “participation rates” and rates that “cap” your upside).
Oh, and by the way, annuities are only required by regulation to return 87.5 percent of your money (not the full 100 percent).
If those annuity owners had invested wisely and consistently in a balanced S&P 500 and government bond market blend, exposing themselves to some risk, their potential upside for that 25-year period was considerably higher, ranging from 6.5 to 7 percent per year.
In exchange for security and the very modest return potential provided by an annuity, you essentially lose significant access to the money you have invested, thanks to page after page of restrictions, lock-ups and handcuffs built into the contract.
I completely understand why individual investors remain skittish about the markets. The past 15 years in the stock market have been a rollercoaster.
A lot of folks – some of them deep into retirement –are still trying to piece together nest eggs that were shattered in the great recession of 2008. But if you are looking for a “guaranteed investment”, annuities aren’t the answer – too many restrictions, too much control from the annuity company, and a bet that the annuity company itself will not run into financial trouble - for too little return.
Instead, if you really want a “risk free asset” and are willing to leave your money invested for a full 10 years, just buy a Ten-Year US Government Treasury Bond that yields between 2.5 to 3 percent per year and hold it.
Not only does the United States of America back your principal, you would earn 25 to 30 percent in interest over 10 years.
That’s about as close to “can’t lose” as you’re going to find. But run the other way if any “company” promises you a guaranteed investment. What happens if the company itself goes away?