Even If The Underlying Index Goes Up 10% , Your Return Will Be Lower

Category: Finance, Financial Planning.

Equity Indexed Annuities( EIAs) have become the hot product of late. I' ll discuss these alternatives in the next two articles.

I believe you can easily find other alternatives that will bring a better return, without locking up your money or levying hefty surrender penalties. But first, you should understand two things: your purpose for investing and how EIAs work. For simplicity let's consider two objectives- -stability and growth. Know why you' re investing. If you are primarily concerned about protecting your investment and earning a stable rate of return then your main objective is stability. It's unlikely that your objective will be 100% stability or 100% growth. On the other hand, if you are concerned about protecting yourself from rising prices, building a retirement nest egg or growing your wealth then your primary objective is growth.

Usually it will be a combination of the two. On the other hand if you' re 75, stability may be more of an issue for you. For instance, if you' re 55 years of age and preparing for retirement, perhaps you' d want about 40% of your portfolio invested in'stable' investments such as bonds or CDs, and 60% invested in equities such as stock mutual funds. You still want to plan for inflation, but your objective is very different from a 55 year- old. Maybe you' ve been told EIAs are the perfect answer. You might have 70% in stable investments and only 30% of your money in equities.

They' re sold as delivering both stability and growth. It seems that an EIA will help you meet both objectives. Salespeople say you can participate in the growth of the stock market without the risk, while always earning a minimum of 3% . Upon closer examination, you will see, though that it doesn' t do either very well. Let's put that in perspective. EIAs are said to provide stability because they provide a minimum return of 3% .

In return for that 3% minimum you are required to keep YOUR money in the investment for many years, or else pay a penalty that in some cases could be the equivalent of over 3 years worth of return! If interest rates increase during those 7 to 12 years, you will be unable to take advantage of them. Moreover, that 3% minimum doesn' t change over the long length of the investment. Imagine how you would feel if you knew you could be earning 5% or 7% in a CD or government- guaranteed bond, but you were stuck in an EIA paying 3% ! So let's take a closer look at the growth offered by an EIA. The stability an EIA provides just doesn' t measure up.

Typically, your investment choices are limited to the S& P 500, or a bond, NASDAQ- related index. If these indexes go up 25% or 50% like they did in 2003, you may only earn 10% to 12% . But EIAs place a limit on how much you earn. EIAs only allow you to only participate in a portion of the index's return, or they have internal charges of 1- 2% . This makes sense when you realize the insurance has to earn back the enormous commission it paid the agent. Even if the underlying index goes up 10% , your return will be lower. The insurance company can' t pay a 3% minimum in the bad times AND allow you to get 100% of the return in the good times.

Don' t stack the deck against yourself. So, in an EIA, you bear the risk of investing in the stock market but don' t get all the return. When you invest in equities you should have access to thousands of choices, and get all the return. No matter how you need to split your portfolio between stability and growth, there are much, believe me better ways to manage your money. The bottom line: why trap yourself in an investment that greatly limits your upside potential and shackles you with outrageous surrender penalties, all for a measly 3% promised return, while your agent walks away with a 10 or 12% commission? I' ll talk about them next week.