Now you can insure your portfolio’s rate of return
By Karlan Tucker
Most of us have insured our cars, homes, health and life; but did you know you could insure your portfolio’s rate of return?
I ask my prospective clients what rate of return is worth risking their life savings for? Five percent? Eight percent? Ten percent? Twenty percent? I think the answer is if losing a portion of their life savings would lower their standard of living, then they can’t afford to risk any of it.
But what if they could not only make a respectable rate of return without risking their principal, but they could also be guaranteed that respectable rate of return? Well, they can; and they get to pick the rate that is guaranteed from 4 percent to 8 percent.
Fixed indexed annuities offer guaranteed rates of return from 4 percent to 8 percent, with fees ranging from 0 percent to 0.90 percent for the privilege of insuring your clients’ portfolios’ rate of return.
These guaranteed rates are available on the income accounts offered inside the FIA. This means that in order to benefit by the return, the account value has to be taken in the form of income. Is this a problem?
To answer that, let me first ask a question: What has largely replaced America’s pensions? That’s right, defined contribution plans.
Today’s plans changed to defined contribution plans called 401(k)s, 403(b)s etc., replacing the former defined benefit plans. What was and is the purpose of a pension? To provide income throughout retirement, right?
What then is the purpose of a 401(k)? What is the one thing a person has to have in order to quit his or her job permanently and retire? Income.
Today’s fixed indexed annuities are masterful in providing income that increases either by a guarantee or by linkage to an index throughout retirement. Before the income flow starts, these vehicles offer guaranteed rates ranging from 4 percent to 8 percent. This grows the account until the annuitant is ready to take the income. The maximum growth period for the guaranteed rate is 20 years, and the minimum is 10 years.
Bull or Bear: we don’t care because the worst-case scenario for the FIA owner is a guaranteed rate of growth at 4 percent to 8 percent. If the owner chooses 5 percent, there is no fee. If he or she selects 6 percent to 8 percent, the fees range from 45 basis points to 90 basis points.
So today, for a fee or insurance premium of 0-90 basis points, your clients can insure the portion of their portfolio’s rate of return that sits inside an FIA.
Let’s say your client chooses the 8 percent growth rate at 90 basis points. On $100,000 the annual guaranteed growth is $8,000 compounded. The fee is $900. So, for handing over to the insurance company $900, your client gets $8,000. Some clients ask me if they can do this more than once a year; and the answer is no, just once.
At 8 percent the $100,000 is guaranteed to grow to $200,000 in nine years. Can you find anyplace else in this current economy where you can insure your clients’ rate of return to guarantee the doubling of their money over the next nine years?
Warren Buffett thinks the market will do well to earn 4 percent to 6 percent for the next decade. J.P. Morgan reports that the average investor in equities earned 2.6 percent annually for the past 20 years, from 1990 – 2010. The Dow earned 5.3 percent from 1900 to 2000, a period of 100 years, by growing from 66 points to 11,497. Peter Lynch’s Magellan Fund posted 17 percent returns for upwards of 20 years; but in a later study it was discovered that most investors in the fund actually lost money due to getting in and out at the wrong times.
Emotions make it very difficult to make money in the stock market let alone an 8 percent return for an extended period.
FIAs are designed to give the owner the greater of the guaranteed rate of return of their income account or the credited performance of the index they link to. If somehow the stock market can credit better than 8 percent annual compounded gains to your client’s account (assuming 8 percent is the rate they selected), then they get the better return. But if not, then their floor is 8 percent when taking income.
Think about it, in an FIA, the risk your client is taking is whether or not they are going to outperform the guarantee they purchased by receiving a portion of the up of the index, thereby rendering the fee they paid for a guaranteed rate of return unnecessary. Or will they have to settle for the guaranteed rate of return?
When “failure” is settling for 8 percent compared to the loss of principal in traditional market vehicles, most will gladly accept that kind of risk.
It’s not a lot different than paying a premium to insure your home should it burn down. If it never burns, you’re happier than if you had collected the policy’s benefits. In the FIA, if your client buys the guarantee and never needs it because the market credits them with gains higher than 8 percent, your client is not unhappy.
However, in my estimation, the chances of the market outperforming a credited and compounded return of 8 percent are slim and none. Even when the market does well, your client’s ability to actually capture the gains in his or her diversified portfolio is very difficult.
Whether using buy and hold, diversification, the Monte Carlo model, dollar-cost averaging or any other market strategy, it would be extremely difficult to actually receive credited gains of 8 percent annually over 10 years and longer.
I have yet to meet a person that retired on unrealized gains. In a fixed indexed annuity, gains are captured for life annually and available for a lifetime to help preserve their standard of living.