Variable Annuity Not Magic Solution

office pictures may 2012 002While driving home recently I was disconcerted by another commercial spouting false information and preying on investor fear.  This commercial was exaggerating the danger and volatility of the stock market by implying most investors lost millions in the 2008 and 2009 market crash.  In reality if you were invested in the stock market from 2006 to 2016 you would have seen a 65% increase in your stock portfolio.  If you didn’t sell when the market dropped, you would have experienced a reasonable return rather than a loss on your investment.   Commercials like this stir up fear and anxiety then promise the perfect solution to market volatility – the magic to provide great returns without taking risk.

There is no miracle product that is going to provide you with high returns without risk.  If it sounds too good to be true, it is!  A basic concept of investing is the trade-off between risk and return.  If you want more return you will have to absorb greater risk.  If you want a risk free investment you will be limited to CD’s and US government bonds that pay very low interest rates.   If you want to earn higher returns you will need to take on some risk and invest part of your portfolio in the stock market.

The mystery product in commercials and ads that promise high returns with no risk is often a variable annuity.  While on occasion the use of an annuity may be appropriate for a portion of your portfolio, most variable annuities come with significant disadvantages.   A variable annuity is an insurance vehicle that invests your money into separate accounts similar to mutual funds.   Annuities are complex insurance contracts that are commonly sold on commission, with built-in fees and significant restrictions on when and how you can withdraw your money.    Earnings on money invested in a variable annuity grow tax deferred but are taxed at regular income tax rates when withdrawn.

Insurance salespeople influence you to buy annuities by promising protection from market volatility.  Basically, in addition to paying the typical fees and commissions, you can purchase an insurance rider to guard against a drop in the market.  However, this insurance usually only applies to a death benefit or the base amount used to calculate an annual income stream.   If you think a variable annuity is appropriate for your situation make sure you fully understand the product’s benefits and restrictions before investing.   Also consider an annuity with no or a low commission and without restrictions on when and how you can access your money.

A better option for managing market volatility may be to invest in a diversified portfolio that supports your time horizon.   Avoid the need or temptation to withdraw money from the stock market when it’s down.  Invest money needed in the short term in safe investments and limit your stock market investments to long term money.