Episode Transcript
[00:00:00] Speaker A: Hello and welcome, everyone, to the Annuity Straight Talk podcast, episode number 135.
My name is Brian Andersen, founder and creator of Annuitystraighttalk.com, here to answer all your retirement questions. I am back in Montana finally, after two plus months. Last week came to, came from Grand Junction, Colorado. I didn't announce that, but that was a good episode with John Bomber talking about the direction of the market. Seems like he was kind of right again. We're going to see a little bit of volatility. We're here to talk to you about something that counteracts volatility with a downside you cannot lose on and an upside that is attached to the market. I want to talk about choosing annuity indexes.
It's a huge topic for everybody who buys an index annuity, and we're going to talk about what that means.
So you can like, please, like, subscribe or comment on any of your favorite podcast platforms or on YouTube. Make a comment, send me feedback, tell me what you want to see. Love to do it. But this is a topic that comes down to what a lot of people ask when they buy an index annuity. And we talk about the, you know, go through projections and we do all the stuff, explain the contract, and then it gets to the application and it's like, then you've got a list of options and you don't know what to do. Most of the time when I answer this question, because I try to educate people really well from the beginning, but a lot of times people will call me, they bought it from someone else, and the guy's not answering the phone, hey, what should I do now? It's my anniversary. I got this piece of paperwork. What do I pick and how best do I do it? So for all those people, the do it yourselfers that buy something from me or the people that get it from someone else, this is a good reference point, and that's what I'm doing it for. The point is, you want to protect your downside and you also want to make as much money as possible. Fair to say. I think so. So when an index annuity has several options, some of them have 10, 12, 15 more options, and it's hard to figure out, hey, what should I do? If you don't pick an index that does really well throughout the year, you had a contract that could have grown, but your money didn't because your money wasn't in there. So when you've got a contract that's got, you know, ten different options, you get to allocate the funds to indie combination of the available indexes when you start the contract, and then at every contract anniversary, you get a chance to redo that. So, if you have ten options in a contract, you could put 10% of the funds in each one of the ten indexes, or you can put 100% in just one of them. Any other combination that falls somewhere in the middle to with 54, with 25% is fine, so long as 100% of the funds are allocated, then you've got something that will work. So we're going to talk about all the options available and how you do that, how you analyze it. This is going to feed into a couple of the podcasts that I did in the past. To start with, every single contract has a fixed rate as one of the options. The building blocks of an indexed annuity is a fixed annuity.
A lot of you guys know of those as mygas, multi year guaranteed annuities. The fixed annuities of building blocks with an index annuity. They're taking that fixed earning and they're buying an option in a market index. So if you buy an indexed annuity, you can take a part or all of your money from ten or 510, 100% and just get a fixed rate for the year. It's a good choice if you lack confidence in the market going forward, if you think, okay, well, like a lot of people in the past would buy this, well, I really like having this contract, and, but I'm not confident in the markets going forward. Buy it, put it in the fixed rate for the first year, decide something later. So if you lack confidence in the market going forward, and you want to maintain the option to go for more potential, then there's the fixed rate. A lot of people have put money in the fixed rate, like a little bit of it, it's like, oh, well, I'm gonna put half the money or 25% of the money in the fixed rate, so that the contract is always moving forward. There's a lot of people I know that really like to check account balances frequently. And so every time you log in, it's always daily interest. So you log into the account every single time you do it, there's gonna be a little bit more money in there, because a piece of it is in the fixed rate and you're always moving forward. So that's the easiest way to look at it, is the building block versus a fixed rate. The next one, before you choose indexes, you got to decide whether cap rate, participation rate or the spread rate is the best. Now, cap rate is a maximum you can earn. Participation rate is a percentage of the index that you get, and a spread rate is a percentage that is skimmed off the top of the index before your interest is credited. This isn't a full tutorial on what all those mean and what they do, but this has been a longstanding argument between consumers and advisors. I get a lot of people coming back, whoa, you showed me the cap rate and the participation rate is better. But a lot of people argue about which is the best way to analyze or get the most interest possible. And the correct way to look at it is to realize that each of these has an advantage in certain times with cap rates being a maximum amount of interest that can be earned. They're going to work best when the market is positive but not up by incredible amounts or credible yield. The market is not always up by 20%. If you got a 10% cap rate and the market's up nine, you're going to get 9% in years when the index moves well into double digits and you'd be better off with either a participation or spread.
The spread is probably offers the highest maximum growth potential because it's just a little bit of interest they take off the top line. But it's incorrect to look at that as saying, well, I just want a participation rate because that shows the best in history.
When moving forward, it's going to be a completely different scenario. So the options with participation rates or spread have unlimited potential. And there's a lot of agents that sell that potential. This is the way to do it. It gives them their edge. It's risky to set expectations there because the market doesn't always, if it averages between eight and 10%, it does not normally exceed that.
It exceeds it by a little bit. So you're better off in a lot of situations with a cap rate. And the best thing to do is to have a contract that offers you both, so that it's not that you'll choose the best one every year, but at least you know it's available to you and you don't have to worry about just being stuck with just, oh, I'm going for the top line. Next one. When we talk about actual indexes, this is very important. Pure equities versus blended indexes. If you track a pure equity index, S P 500, Nasdaq, Dow Jones, Russell 2000, those are just tracking market cap based indexes. It's easy, and at any point in time, you can go look at what the value is. You can compare it to where you started. And it's simple. If the market's up. If that index is up, you get a piece of it. I have in the last year or two gone to just illustrating these, when someone's looking at a contract, look at this index because it's easy to understand, easy to verify and look at it. I can show you a lot bigger numbers, but it's not always realistic. And you have to look at how those other indexes are tracked historically, how those gains are calculated. So blended indexes are administered by investment banks, partnership between a bank and an insurance company. They have bond components, cash or treasuries, and employer risk control strategies that limit volatility.
They go into a full explanation of how that works. But I covered in a podcast last year, if you want to think about it, and everybody new coming in who just sees this maybe as the first one, there's a link in the newsletter. Go back to that podcast from August 30 of last year, said crazy annuity indexes. And I explained in detail how that works. And essentially, you look at a stock bond portfolio in the last two years, not even, not talking about annuities, but look at a stock bond portfolio. Stocks are up, bonds are down, those two balance out. If that's in an index and that works in an index, then you've got flat performance.
The blended indexes typically have more consistent rates as far as like cap participation, spread, all that stuff. It's an agreement between an insurance company and a bank. It ensures long term pricing.
You won't see as many rate adjustments or as bigger rate adjustments here, because options pricing is consistent. They're slow movers. They don't move that quick. They're not built to grow aggressively. They grow consistently. So a lot of the fancy illustrations you'll see are based on a cash or bond component. In the past, with consistently falling interest rates. From 1990 to 2020, interest rates steadily dropped only a couple of periods in there where they slightly rose a little bit. If you illustrate a stock bond portfolio, this is one of the faults of traditional investment planning, and stocks and bonds altogether is that historically bonds were always increasing in value because rates continued to drop. So you have to understand, if you're looking at a historical scenario in an illustration, is the future going to do the same thing?
And that's something, a concrete fact that you can rely on when analyzing it. That's why I use equity based indexes going forward, because we can't expect to replicate the falling interest rate environment for 30 years like we had in the past 30 years. So all of those indexes over the past couple years have been flat, just like a traditional stock bond portfolio. And I want to educate you ahead of time. So you look at that podcast from March 24 of last year, 2023 B's annuity illustrations. I talk about that in detail, and it's not to say that annuity is bad. It's not. The contract is bad. But you understand that those index options are beneficial at a certain period of time. In addition to that, in the blended indexes, they have risk control measures that will mute the returns. It can be a good thing when markets are really volatile. It'll give you maybe a decent, a little return when the market is flat or negative, but it's going to lag behind when the market's moving forward. Most of the blended indexes have a 5% volatility target. Those podcasts above will explain that if the volatility index is 20%, then a 5% volatility target is only going to allocate 25% of the funds to an equity side. The rest of it is going to be in a fixed side, either cash, bonds, or treasuries. And you can see if it's only exposed in small part to the equities market. It's not going to grow near as much as the stock market, and a lot of the weight is going to depend on what happens with that fixed asset base. So there are a few indexes that come with a 10% or 12% volatility target, and those are going to move far more aggressively because those fall close to the average of what the volatility index is. So most of the time they're exposed to the equity side. You'll see a little bit more variability in the rate, but that's where you're going to see your largest returns. So allocations to any of these are going to depend on what the index offers. On the safe side, if it's cash, it's not as interest rate sensitive as a bond or treasury. If interest rates continue to be volatile, then most of these should be avoided in the near future. Good to have them there, but maybe stay away from and think about that. If you want to know where you can look at the past ten years and oh man, that index looked great. Well, it's illustrated over a falling interest rate environment. So the safe side of that portfolio boosted in value, and the little bit that was in equities increased as well.
Those two combined. If you don't have that boost in value on the safe side, you're not going to see the same performance going forward. If we have a precipitous drop in interest rates go in the future then, and some people will say, well, I think interest rates are going to drop. Well, then go into one of those indexes because you probably see a really nice yield. But these are the things you have to figure out and decide if that's what you want to play and that's a risk you want to take. Alternative indexes several of the contracts I like will give you options that are not at all related to stock or bond markets. You want to stay out of, like interest rate sensitivity, variability and volatility in the stock market. You want a contract that has one of these as well.
So there might be some correlation to the overall economy with these ones. But there are a lot of periods of time when an alternative index gives you positive growth when it's not available in the stock or bond market. Index is based on commodities or real estate.
So you have pure commodity indexes, you got gold index, you got real estate, a nice option to have so you can diversify options or even attempt a positive credit when equities markets have a bad outlook. 2020 until now has been a good period for gold and real estate, where the blended indexes didn't do that well in the past couple of years. If you had a gold index massmutual ascend real estate massmutual ascend blended index from midland national with those elements in there, you had good indexes that performed over time when everything else was pretty flat, and then the equity based index as well worked also, depending on when you started, when you stopped, when your point to point was so a lot of different ways to work it and the way to choose, again, pick a good product that has a little bit of all of this. You're going to want to choose a blended index when markets are, when interest rates are projected to be stable or falling, equity based index when rates are rising because the bond value is going to fall. And then you want the equity exposure, which has happened in the last couple years, to increase in value. And if you don't know what's going to happen, alternative indexes I'm not crazy about gold going forward. But again, if you got a contract that's got a gold index and an equity index, s and P 500, you got both of them, then you always got the fixed rate. There's always a way to make money in an index annuity. So the question is, how do you choose? I got three ways to make your decision every year, okay? About half the people I work with say, oh, I don't know just do what you think is best. If you're one of those people and you do that, I'm still going to explain it to you and make sure you understand why I'm doing it and agree with it because it's not my money. I'll do my best, but you have to agree and confirm the direction. There's the analytical types that are going to overanalyze things and stress about options. Every single year, laid back people will just pick something in the beginning and they're going to let it ride. And I suppose they figure that, you know, things will average out, which they do, and typically it works just fine. And the third one is to diversify each year, change it a little bit, but always keep exposure to any of the different options because all of them work at different areas. So if you want a guide on how to allocate your index annuity, there's a big thing. Fixed rate equity exposure, bond fluctuations. Alternative indexes have a contract that's got at least three of those four. So everybody's got the fixed rate. So have some alternatives, have a way to make money. Do your best. Don't over analyze it. Some people will because you're going to be wrong sometimes, you're going to be right others. But anyway, that's how you choose annuity indexes from the beginning through the contract period. For anyone who buys it with me, I'm here to help you figure it out. And I look forward to the conversation every time because we get to revisit all the reasons why we did it in the first place. And a lot of times, like right now, we're dealing with guys that are coming through getting nice interest yields. I'm going to come back next week because I'm going to remind you of something I did last year about index annuities locking in guaranteed yields. But this has been episode 135.
Brian Andersen here choosing annuity indexes.
Go ahead, like subscribe or comment on any of your favorite podcast platforms or on YouTube, please. If you want to talk to me, the best way to do it is hit the top, the button on the top right corner of any page on annuitystraighttalk.com dot. Schedule a call. Write your name, your time, some notes about when you want to do it. I will call you when you put your phone number in. That's the only way I'm going to do it. Not going to bug you at all. But if you schedule an appointment, that's how you do it. You want to get a hold of me? I'd be happy to chat with you. I'm going to see you next week for episode 136. Thank you guys so much for stopping by. I'll catch you soon. Okay, bye.
[00:18:05] Speaker B: You have been listening to annuity straight talk.
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