One of the biggest decisions to make when investing is to decide how much money you want exposed to market risk and how much you want in a safer place. Do you like the idea of the potential gains to be made in the stock market, but don’t like the risk associated with losses? Insured investments can augment your portfolio nicely. An insured investment is one that is backed by an insurance company.
These can take the form of a Fixed Annuity, a Variable Annuity, an Indexed Annuity or various other types of insurance including Indexed Universal Life Insurance Policies. These can often be complex products and detailed understanding of your financial needs as well as an understanding of the product on your part is essential.
A fixed annuity is good for someone whose primary concern is not to grow their money or to have it be liquid, but who wants to be certain that it does not go down in value. Money in a fixed annuity is backed by the issuing insurance company, and the interest rate is stated up front by the insurance company. Much like CD’s in recent years, the interest rates on these products have been lower than normal. But generally speaking, the longer you commit your money to the product, the higher the rate you will receive.
One of our clients, as she aged, became nervous about the stock market. She would have liked to have had her money in a CD but couldn’t get a satisfying return. We explained the fixed annuity to her and she decided to carve out some money for this investment. She now knows that whatever happens in the market, she is guaranteed to make a predetermined return on this lump sum.
An indexed annuity is like a fixed annuity in that your money is not invested in the stock market and you will not lose principal. However, you have an opportunity to participate in any stock market gains up to a point (called a cap) if the market goes up on a given year. In years when the market goes down, your money is protected and you will not lose principle or any gains earned in previous years. These will likely have longer holding periods than the fixed annuities.
One of our very savvy investors who had minimal investment experience, got divorced and suddenly had to make these decisions herself. However, we call her “savvy” here, because she knew herself – she knew what would provide her peace of mind. She was very clear from the beginning that she wanted at least half her money in something that could not go backwards. We spent multiple meetings educating her on the choices available to her, the pros and cons of each, and when she felt she understood them, we were able to create a portfolio in which she felt confident and at ease. For her that meant an Indexed Annuity.
A variable annuity will guarantee an income stream based on a percentage of the assets, for life, regardless of if the lump sum goes down in the market. These are pretty complex products and we have found many people who misunderstand them so we like to meet several times to make sure clients understand all the moving parts. Variable Annuities are good for someone who wants to guarantee an annual income, but is okay with their principal moving up and down with the market.
We had a client who was nearing retirement and was nervous about not having the peace of mind of getting his pay check every month. He had saved a large lump sum over his 40 year working history and was proud of it. He liked the idea of the stock market but watching the fluctuations made him very nervous. Upon discussion, it appeared that his largest concern was knowing he can always count on an income stream, no matter what happens in the market. He liked the idea of a VA very much.
Indexed Universal Life Policies (IUL):
IUL’s are a great alternative to bonds when bond yields are at historic lows. This might be an excellent option for someone who wants to participate in some of the upside of the market, but doesn’t want to lose any principal if the market goes down. In addition, you have a life insurance benefit that with some policies can also be used for Long-Term Care if needed.
A client of ours was stock piling cash in his bank account because the market was making him nervous. But, when we discussed it, it was more than he needed for an emergency fund and he was uneasy that the cash wasn’t making a return, so he hadn’t solved his problem of peace of mind. However, he felt stuck because he didn’t want the money to be tied up in case he needed it at some point. We discussed an Indexed Universal Life policy that would allow him to make some decent gains, not lose money when the market was down, and also keep the money accessible to him if he wanted to move it elsewhere or use it in a pinch.
One of the down sides of insured investments can be a long and somewhat illiquid holding period. This can be frustrating as circumstances change and you may decide you want to put your money elsewhere. At HFS, since we are not tied to any one company, we can work with almost any insurance company, and we have found IUL products that in some cases have no penalty for exiting the investment at all. These are the ones we generally advise for the above reasons.
At HFS we specialize in educating and partnering with you to analyze your financial goals to put together a portfolio that helps you rest easy at night. For people who cannot tolerate losses of any kind, fixed annuities, indexed CD’s, indexed annuities or an indexed universal life policy can be a great fit. For others, who want to participate in a higher upside, perhaps having just a portion of their money in an insured investment is the answer. Others still, who are comfortable with risk, will not choose this route at all.