Here at AnnuityGator.com we regularly break down popular annuities and “test” them to determine what your realistic annuity returns expectations should be. This exercise has been fun, but it is hypothetical – i.e, it’s based on taking their current structure and using historical data to see what they would have done in the past.
We saw a cool article that showed what the average annuity return index performance was between 2007 and 2012.
The study was done by Advantage Compendium, it’s based on the actual annuity returns of real index annuity policies, not back-tested or hypothetical returns.
Study Of Average Annuity Returns for Fixed Indexed Annuities
Here’s what the study found:
Annually, the average annuity return of all actual fixed indexed annuities in the study was 3.27%. The range of annuity returns was 5.5% average annualized (best) and 1.2% average annualized (worst).
This time period takes into account the roller coaster stock market during the 2008 economic recession, and the few years during the “recovery.”
On the surface, this doesn’t sound too bad. However, it really depends on what you compare them to. For example, during this same time period, here are the returns of a couple of no load, low-cost index funds; as well as some blends of the two showing some simple asset allocations:
|Average Annualized||Best||Worst||Worst Possible 12 Month Period|
|Vanguard Total Stock Market Index Fund||-0.07%||n/a||n/a||-43.14%|
|Vanguard Total Bond Market Index Fund||6.50%||n/a||n/a||0.25%|
|50/50 Blend of Vanguard Funds Above||3.68%||n/a||n/a||-23.09%|
|20/80 Blend of Vanguard Funds Above (20% stock / 80% bond)||5.49%||n/a||n/a||-8.68%|
If you’re wondering why there are n/a in the best and worst columns for the index fund (non-annuity) sets – it’s because there is no range of returns. The only returns would be the average, whereas there would be varying degrees of annuity returns between the best performing contracts and the worst.
This study isn’t meant to be a recommendation for or against any of the above investments. It’s more about understanding average annuity returns and the risks of different investment methodologies. There are some interesting things we noticed, however:
- Since the stock market was pretty awful during the time frame of the study, it’s not surprising this was the worst of the investments in the table
- A lot of people might be surprised that bonds were not only the best but also had the least amount of risk (based on the highest worst 12 month time period)
- Balanced investors still had some bumps in the road, but conservatively balanced investors (the 20/80 bunch) actually did much better than most would think
- If you were lucky enough to invest in the best possible index annuity from 2007-2012 you did about as well as a conservative (20/80) investor in index funds, otherwise, the only investors you outperformed were investors heavy in stocks
- The indexed annuity returns do not take into account surrender charges – so in reality, the liquidation value returns would be slightly lower than 3.27% average; whereas index mutual funds are fully liquid at all times, and generally with no penalty at all
One of the reasons we like studies like this is that a lot of annuity salespeople like to always compare index annuities to the stock market. That’s apples to oranges, though.
A much better proxy is to compare returns to other conservative investments, even if they’re not guaranteed like annuities are (based on the claims-paying ability of the insurance company).
Average Returns and Actual Returns are Not the Same Thing
Another super important thing to keep in mind is that many financial advisors like to talk about average returns when they’re presenting you with an investment. But here’s the thing, average returns and actual returns are not the same thing. In fact, they can actually be very different – and somewhat disappointing if you focus only on average and not actual.
In order to set the stage, you first need to understand that if the value of an investment falls by a certain percentage, it will need to gain a larger percentage than it dropped in order to just get you back to even.
For instance, let’s say that you invested $1,000. In the first year, the value drops 50%. So, you’re left with $500 at the end of Year 1. The following year, the investment goes up 50%. But even so, you don’t have your original $1,000. Rather you’re still down $250 – even though the “average” return over the two-year time period is 0%. So, the actual return is a negative 25%.
|Original Investment: $1,000|
|50% drop in Year 1: $500|
|50% gain in Year 2: $750|
In fact, as long as there are any negative numbers in the mix, the actual return on an investment will not ever equal the average return. In his book, The Retirement Miracle, Patrick Kelly sums it up very well.
In this case, let’s take another $1,000 investment. Over a ten-year period of time, the return fluctuates between a 10% and a 10% loss as shown in the table below. Here again, the “average” return over the ten years is 0%. But the actual return is roughly negative 5%.
|End Of Year||Gain or Loss||Value of Account|
Source: The Retirement Miracle. By Patrick Kelly.
With that in mind, it is important to make sure that you don’t base investment and retirement income decisions solely on the “average” return of an investment.
When we analyze annuity returns in this regard, we can see that they’re not bad at all, but there are other options conservative investors might want to consider instead or in combination with annuities. There’s no one-size-fits-all approach and positives and negatives with all investment strategies.
Plus, I’m sure you’ve heard the phrase, “don’t put all your eggs in one basket,” right?
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