Not long ago I wrote my scathing review of Dateline NBC’s expose on Indexed Annuities, but I’d like to start over from a slightly different angle and provide some insight as to why indexed linked products – whether they are CDs, corporate notes, life insurance, or annuities – offer certain advantages that no other products can touch.
Firstly, you have to realize that the long-term growth of the S&P500 doesn’t reach into the double digits. What makes the long-term average of the stock market reach 11% to 12% are the dividends. You also have to consider that without dividends, the average returns of the market without dividends from 1951-2001 (looking at 10 year periods), was 9.49%.
On the surface, critics will correctly point out that indexed-linked products will return about 60% of the actual gains of the market over the long-term. This is really a half truth, and pretty deceptive. You see, the way they figure that 60% figure is by simply adjusting for cap rates and participation rates of index-linked products.
If you are not familiar with how index-linked annuities (or other products) work, stick around and browse through the archives of this website. The short and sweet of it is that these products credit your account according to the upward movement in the stock market up to a cap. The cap is known in advance, and it’s typical to see cap rates of anywhere between 6% – 8.5%. Obviously the better contracts offer higher crediting potential, and in most cases, it is preferable to have higher caps with no fees attached to the product.
However, by assuming that index-linked annuities return 60% of the market, you have to calculate the down years. After all, the stock market doesn’t always go up. And herein lies the problem. That 9.49% average is a true average. The down years have been figured in. But index-linked annuities (and other products) treat down years as a zero. That’s the nature of the beast.
By the time you substitute all of the down years with zero, an equity indexed annuity actually returns 30% more over that initial 60% assumption. This is how the long-term honest return of an index-linked annuity can reach into the 8% range. If the growth rate of the S&P500 is 9.49%, 8% with no downside risk isn’t really that bad….is it?
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This entry was posted on January 2nd, 2012 by David C Lewis, RFC. Edits may have been made to keep this entry current. · No Comments · Investing