Return illusions -- risk and volatility

Assuming safety means higher returns

Hand in hand with this is a belief that less-principal risky investments have higher returns. I have read several surveys asking retirees whether stocks or bonds produce higher returns over time and the majority choose bonds. Why? Because they believe bonds simply have to produce higher returns because they don’t go up and down as much as stocks.

Rules of thumb help annuity sales

Risk and volatility are two separate things, and there actually is a relationship between risk and return – taking higher investment risk does usually result in higher returns. But it doesn’t seem correct to most consumers that a vehicle that protects them from market loss should produce a lower return than one that does not.

However, the mental rules of thumb used by consumers help to put money into banks and annuities. Consumers are predisposed to assume that accounts wherein principal is protected and where they believe the earnings have less fluctuation will produce higher returns over time than ones that do not.

What does this mean to the annuity producer? If the producer is presenting a multi-year rate fixed annuity the consumer is seeing that as the “top wheel” and will be inclined to view it favorably.

If the producer is presenting an indexed rate annuity and trying to move money from the bank, the consumer is seeing the index annuity as the “bottom wheel” because of the possibility of years with low or zero indexed benefited interest. The producer needs to remind the consumer that they are not buying the annuity for simply next year’s interest, but are in for the long term, and to talk about how many spins of the wheel translates into more opportunities to earn more interest than the bank pays.

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