With bond yields at such low levels, some advisors are ill-equipped to find other ways of de-risking their clients’ portfolios, especially as they approach retirement. In his latest research, Roger Ibbotson, the economist known for his Stock, Bonds, Bills and Inflation chart, argues that fixed indexed annuities have the potential to outperform bonds in the near future and smooth the return pattern of a portfolio, given their downside protection.
Ibbotson’s seminal work was around the idea that as you take on more risk in a portfolio, you get a higher return. But that risk is volatility, and as one approaches retirement, they can’t afford that lack of stability.
“I’ve always recognized you have to de-risk, and we see that bonds are not necessarily the way to go today because the yields are so low,” Ibbotson said. “It’s pretty hard to have a falling rate environment today, when yields are below 3 percent on bonds.”
When added to a portfolio, fixed indexed annuities can smooth out the return pattern, he argues. A fixed indexed annuity is a contract issued and guaranteed by an insurance company; it is a tax-deferred accumulation vehicle whose growth is benchmarked to a stock market index, rather than an interest rate. They offer capital protection and they’re typically structured as 7 to 12-year products. Liquidity is provided with penalty-free withdrawals of 5 to 20%, depending on the product. Most uncapped products—which are the ones Ibbotson simulated here—are based on an index subject to a floor of 0% and a participation rate.
In good years, you can make a lot of money because of the equity exposure, but when the stock market goes down, you won’t suffer a loss since your return will never be less than zero.
