Choosing the correct index option for your client's annuity
By Jason Kestler
Kestler Financial Group, Inc.
Many popular market indices are used to evaluate performance. Several of these are available to investors for benchmarking, investment portfolios or dictating growth on equity index annuities. For the sake of this discussion, we will focus on the latter: What is a market index, and which is the best choice for my client’s index annuity?
An index is a group of securities reflecting a securities market or a particular segment of a securities market. It is used to measure and report the fluctuations of the market it represents. Each index targets a certain group of equities (stocks, and/or bonds) and reflects the net result of fluctuating daily values for all equities in the group.
Indices can be broadly classified into two main categories: stock indices and bond indices. As you might guess, stock indices track the stock market, and bond indices track the bond market. Largely because of the popularity of stocks over bonds as a vehicle for the average investor, stock indices far outnumber bond indices.
The most commonly used index with fixed indexed annuities sold by life insurance companies is the Standard & Poor’s 500 Index (S&P 500). This index includes 500 large-cap companies representing about 80 percent of the total market value of U.S. stock markets. The S&P 500 includes almost 400 companies that are listed on the New York Stock Exchange (NYSE), about 75 that are listed on National Association of Securities Dealers Automated Quotations (NASDAQ), a few that are listed on the American Stock Exchange (Amex), and a few foreign corporations whose operations are well represented in the Unites States. Known as a very broad or extensive indicator, it closely reflects the industry allocation that exists in the total market.
Nasdaq is an electronic linking of securities dealers across the United States to facilitate the trading of many stocks not listed on the major stock exchanges — sometimes called over-the-counter stocks. Nasdaq is a wholly owned subsidiary of the National Association of Securities Dealers (now FINRA).
All stocks in the Nasdaq 100 Index come from the top 125 eligible securities in terms of market value. To be eligible, a U.S. stock must have a minimum average trading volume of at least 100,000 shares per day, and must have been listed on the Nasdaq for at least two years. The NASDAQ 100 Index includes 100 of the largest domestic and international non-financial companies listed on the NASDAQ market. This index includes both U.S. and foreign stocks, and reflects companies across major industry groups, including computer hardware and software, telecommunications, retail/wholesale trade and biotechnology. Historically more volatile, you can expect greater gains and losses with the NASDAQ 100.
Another commonly used stock index is the Dow Jones Industrial Average (DJIA). Dow Jones and Company owns the index as well as the Wall Street Journal, which is the dominant daily business publication. The DJIA consists of 30 of the largest American companies in major industries and is often referred to as a representation of the performance of strong, financially secure companies. All of the 30 companies are traded on the NYSE except Intel and Microsoft, which are traded on the NASDAQ. Although the DJIA consists of only 30 stocks, these stocks represent a fifth of the $1 trillion-plus market value of all stock traded, and about one-fourth of the value of stocks on the NYSE. This index should be expected to represent the blue chip or large–cap stocks, such as AT&T, Coca-Cola, Dupont, GE and IBM.
Although bond indices are not followed as closely as stock market indices, they are a very important option for equity index annuities. You can expect very consistent but conservative returns if your EIA is based on a bond fund. One rule of thumb is that bond returns increase as interest rates decrease. Conversely, as interest rates rise, you can expect lower returns on bond funds.
The Financial Times Stock Exchange 100 Index (FTSE 100) is a market capitalization-weighted stock index of the top 100 companies in the United Kingdom. These companies are ranked according to their market capitalization. With ever-expanding global marketing and an interest in international investments, this index provides an opportunity for international diversification.
Published by the Frank Russell Company in Tacoma, Washington, the Russell 2000 Index consists of the 2,000 smallest companies in the Russell 3000 Index. The Russell 2000 Index offers investors access to the small-cap segment of U.S. equities. It is constructed to provide a comprehensive and unbiased small-cap barometer, and is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set.
Your choice of the index used to determine the growth your client’s annuity premium should not be made lightly. Review the options with your client and match their risk tolerance, growth expectations and financial goals to your index options.