The “Rosemary’s Baby” of Investment Products


Talk about an investment where the glass is always half empty! Indexed annuity products are the eternal pessimists.  The fact that they do not include dividends in their return calculations pretty much guarantees they will miss about half of the markets historic gains over time.

In a not so shocking turn of events, these products are often found in the murky waters of the 403(b) world. They are also embedded in the portfolios of many elderly investors seeking “protection” from market volatility.

Dividends play a huge role in stock market returns. Morgan Housel reveals a statistical gem in this brilliant post.

It’s hard to believe that over the last 100 years the S&P 500 rose 273-fold, but, adjusted for dividends, it rose 18,520-fold. Never has so little attention been paid to a portion of investment returns that matters so much.

Now, imagine if someone approached you with an investment that promised market returns with little risk. Better yet, this could also be accomplished without including reinvested dividends!

This pitch violates all precepts of rational evidence based investing. Insurance companies have given birth to the Rosemary’s Baby of finance, the fixed-indexed annuity.

According to a warning from the Florida Department of Financial Services:

Often touted as a way for investors to realize stock-market-like gains without the risk, equity indexed annuities have proven confusing to some investors who have complained to the Department of Financial Services Consumer Helpline of being misled about how the product works or not having their expectations met.  These products can come with hidden penalties, costs and fees, and hefty multi-year surrender charges and may not be ideal for some senior citizens.  

In addition to these wonderful features, here is the real kicker.

Most fixed-indexed annuity increases are tied to index increases deriving from market price changes only, and exclude any increase due to the payment of dividends. For example, in 1998 the total return (i.e., capital gains and dividends) for the S&P 500® Index as reported by Ibbotson Associates was 28.6%, while that for just capital gains (i.e., market price) was 26.7%. A fixed-indexed annuity tied to the S&P 500® Index would typically use the smaller (26.7%) return. Couple that with an example participation rate of 90%, and the increase in the indexed annuity becomes just 24%, some 4.6% below the total increase of the market index. And remember, historically dividends have made up 40% of the total S&P 500 ® return! (AnnuityFYI)

So when all is said and done, fixed-index annuity investors receive the following:

  1. Bond like returns with many unnecessary layers of complexity
  2. Hedge fund like fees.
  3. Steep surrender charges greatly reducing liquidity. Translation, you can’t sell this crap when you might need to.
  4. Counter party risk that is unnecessary. Since you are transferring your risk to an insurance company, an investor is at the mercy of the insurer’s financial situation. Insurance companies can go bankrupt.
  5. The upside is capped and often reset. This means the market can go up 15% but an investor’s maximum gain may be 5%!

These products are so deceptive regulators forced the insurers to rename them fixed index annuities from their former misleading name, equity indexed annuities. In the words of Jane Bryant Quinn“They were sold as being linked to the stock market and that you could make some market gain. But as soon as the regulators started [scrutinizing] that, the name was changed to fixed index annuities.”

 Unfortunately, this product is sold and not purchased. The reason this confusing and misleading investment is found in many retirement portfolios are two-fold. First, it falsely promises the impossible, high returns with no risk. Second, there are tremendous financial incentives in the form of high fees and other perks for conflicted salespeople to push this product upon teachers and other unsuspecting investors.

Neither of these reasons are sound criteria to have an indexed annuity or any other investment in a retirement portfolio. The results have been sad yet predictable.

There is no chance you will travel faster than the guy next to you if you are rowing against the current and he isn’t. When it comes to fixed-indexed annuities, the current is twice as strong.

High fees and the exclusion of dividends will literally sink your investment boat before the race even starts.


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