Stone in Kiplinger: “How Index-Linked Annuities Buffer Against Market Shocks Like the Coronacrash”

A Ballet of Black Swans

Investors over 40 have now experienced several so-called black swan events in the last 20 years. These are those “once every 100 years” financial haymakers that drop our investments to the mat with fearsome efficiency. It is remarkable that Gen-Xers had their 401(k)s and IRAs staggered by not one but two black swans by just the second decade of their working lives: the dot com bubble and the Great Recession.

In spite of the long bull market that followed the Great Recession, or because of it, risk-averse and loss-averse investors may have felt a bit queasy about seemingly untenable market valuations, paltry yield in fixed income, and market reactions to a growing divide in the volatile political landscape. Things got pretty strange earlier this year and there have been few places to turn for safety.

Enter COVID-19

Then came another black swan: the COVID-19 pandemic. Forced social and economic shutdowns aimed at flattening the infection curve sent the punch-drunk global economy reeling. Briefly. Nearly nine months later markets seem to have divorced themselves from reality as they reach record highs during a period of withering unemployment, and innumerable business failures. Near-term uncertainty prevails.

Meanwhile, a couple of relatively new protection solutions have enjoyed growing popularity over the last couple of years: fixed indexed annuities (FIAs) and index-linked annuities (ILAs). If folks are seeking alternatives to fixed income for diversification, these could be viable options. And though they may appear to be very similar—performance follows indices and include caps and participation rates—there are some important differences.

An index linked annuity is a kind of variable annuity, so its risk profile is a bit different than the fixed indexed annuity. Unlike FIAs, index-linked annuities don’t prevent all losses, so the protections are hedged a bit differently, and the return profile isn’t as sensitive to interest rates. This may be why growth in sales of index-linked annuities outpaced fixed indexed annuities in the first quarter of this year when the Fed lowered rates to protect growth, and FIA caps were effectively neutered.

The ILA IRL (Hypothetically)

Index-linked annuities are relatively new. And fee-based versions of them—and FIAs for that matter—have only been available for a couple of years. Folks don’t have a lot of experience with them. For RIAs who are curious about implementing them for clients who may have experienced one too many “once-every-hundred-year” economic events the question is: how would one of these things behave in real market conditions?

In an effort to answer that question, David Stone created an analysis for Kiplinger that aims to see how a $10,000 investment in a hypothetical fee-based index-linked annuity may have performed over the last five years—a period that includes several market drops.

Read the article to learn how an index-linked annuity may benefit risk-averse and loss-averse investors who’ve take their fair share of financial body blows.