The (Black) Magic of Indexed Annuities

Mark Hume |

Volatility in the equities market and a recent yield curve inversion has many households fearful about a recession.  A recession means that the value of their stock holdings should fall on paper, and this incites fear.  Fear is a bad mindset when it comes to investing in stocks. 

The money you invest in stocks should be money you don’t expect to need for a long period of time, say 10 years or more.  So, today’s price really doesn’t matter as much as it does to most.  But it does matter to most.  Because we are human and we don’t like to see our value decline, especially if we didn’t get to spend the money!

We have been asked to review a couple of products that people have purchased and a few more proposals that people are considering.  These products are called indexed annuities or fixed indexed annuities and they are accompanied by some very eye-catching sales lines with little to no explanation beyond catch phrases like:

“It has no fees!”, he says.

“You can’t lose money!”, she says.

These are the focus points of insurance salesmen who are highly incentivized to get your signature on an indexed annuity contract.  We don’t see how contracts could be in your best interest.

Remember what “they” say about if it sounds too good to be true?

The basic premise of an indexed annuity is that if the stock market is down, your account value doesn’t go down.  And if the stock market is up, you get to participate in the upside (some of it anyway and the cap is a BIG deal).

There are usually pros and cons to every situation in life so let’s review the pros and cons of indexed annuities.


  • None, really.  But technically, you have outsourced the management of your investments to someone else which should prevent you from making irrational, emotional choices.  But you give up way too much for this to actually be a pro


  • It is not free.  Nothing is, including financial services.
    • Each one of the products we have reviewed this year had an annual admin charge of just under 1%.  So yes, you can lose money during down market years.  Each insurance salesman minced words and stayed focused on concepts like, “no management fees”
    • Each one of the products we reviewed had a surrender charge and was typically 8 years.  This means if you have buyer’s remorse or just come to your senses, you are punished severely for making this mistake
  • When our client’s stock portfolios are down, their bond portfolios are typically up.  This means when we rebalance, we get to sell securities that have gains and buy securities that have losses (Buy low and sell high.).  Most of the indexed annuities we reviewed this year were tied to the S&P 500 or a derivative of that index. There are no bonds in this investment and thus, no opportunities to sell something up and buy something on sale
  • This is an INCREDIBLY PROFITABLE product for the insurance company.  Your upside is capped.  This means that if the cap is set at 8% this year and the S&P 500 is up 22% like its total return was in 2017, the insurance company pockets 14% of the profits that year.  Is that free?
  • Regarding the cap, it is adjusted each year.  We reviewed one in late 2018 that had a cap of 4.5%!  What if the S&P had another 20% year?  How much in profits did you hand deliver to the insurance company?

Where do individual stock investors reap the most upside?  In years when returns exceed the average.  If you have ever studied stock market returns, they are not typically average in a single year.  They are typically well above or well below the average.  So, the biggest benefit to being invested in stocks is all going to the insurance company.  Are you so wealthy that you can donate double-digit percentages of your profits to an already wealthy insurance company each year?  I’m not.

“But when the markets are down, I don’t lose money!”.  Remember what I mentioned earlier?  The money you have invested in stocks is not money you need today and tomorrow.  It is money you need several years from now.

You can afford to tolerate the ups and downs of price action that accompanies all stocks if you have clearly defined financial goals and money appropriately allocated for those goals. 

If you have $1 million and retired yesterday, do you need all $1 million tomorrow?  No, you only need a tiny portion of that to live on tomorrow and a small piece of it to live over the next couple of years.  You also need money to live on in your 70’s and 80’s.  The largest portion of it needs to be invested to grow and outpace inflation so that you can maintain your purchasing power.

Down stock market years don’t feel great.  But they do provide opportunities if you can maintain a mechanical, non-emotional mindset about your long-term money.  You don’t need to pay tens of thousands of dollars to an insurance company in a single year to positively affect your short-term psychological mindset about your investments.  A local therapist would be much less expensive and have a far greater impact.

In summary, if you are an individual, you are not wealthy enough to share a large chunk of your annual profits with a very wealthy insurance company.  You should keep those profits for yourself to share with your family making memories through experiences or however you like to spend your time and your money. 

-Mark Hume-