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Portfolio > Economy & Markets > Fixed Income

How to Get Fixed-Income Clients out of Their Holding Pattern

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Many producers struggle to provide their fixed-income clients with attractive options to boost their returns. The challenge is, how can you pursue higher returns without exposing the client to significantly higher risk? Because while a client who loses money on equities may get upset, a fixed-income client who gets a down statement might just get a new advisor.

In many scenarios, these clients have a significant amount of money in bonds or CDs. They have benefited from the relative stability of these instruments throughout the recent economic turmoil, and are justifiably apprehensive about re-entering the equities market. Even those who understand the benefits of some market exposure may remain edgy, holding their bond positions a little longer as an endless series of job reports and foreign economic developments reinforces their impression that the “timing isn’t right.”

Sitting tight, however, may not always be the best choice. The fear right now is that, as interest rates start to rise, clients who invested in bond mutual funds to preserve their wealth will indeed see their NAVs drop. What’s worse, as interest rates begin to rise, bonds will see lower flows, which means the NAVs will remain lower for a longer period.

Producers may be able to pre-empt this situation by investigating the suitability of an indexed annuity for these clients. Indexed annuities (IAs) have a few features that make them a potentially attractive alternative to bond or CD investments in the current environment.

1. Potentially higher interest crediting

Since these IAs are tied to an index such as the S&P 500, there is the opportunity to earn a solid return within the product. Although cap rates can change, these annuities currently might have a 4 percent to 6 percent cap rate. This means that if the index rises, the client could earn a credited rate up to that cap rate, which creates the potential for comparatively attractive returns given the current environment: Money market returns currently are extremely low; three-year CDs might offer over 1 percent; even 10-year CDs might only get the client 3 percent in today’s historically low-interest-rate environment.

2. Downside protection

As noted earlier, fixed-income clients don’t like to see down statements, and with index annuities they won’t. There is no principal fluctuation due to the product’s downside protection guarantee. CDs and bonds have this kind of downside protection only if held to maturity. This is also important for the producer: Trail commissions, like customer accounts, don’t go down.

3. Annual reset

With equities, if the client experiences a 20 percent drop in the course of a year, they need that investment to achieve a 25 percent rise the following year to be “whole” again. With an annual point-to-point cap strategy in an indexed annuity, however, if the index drops 20 percent in a year, the account value cannot drop below the value on the previous anniversary date. So the client benefits from any subsequent index gains above that value.

4. Tax deferral

With the annuity, clients also have the advantage of tax deferral, in contrast to CDs, which accrue interest that’s taxable each year.

5. Withdrawal benefit

Like other annuities, indexed annuities typically give clients options for guaranteed minimum withdrawal benefits for an additional cost. With these benefits, clients who are retiring can turn on an annual income stream that will ease concerns that they might outlive their assets. The annual income amount represents a percentage of their account balance, with the guarantee that they’ll be able to continue to withdraw that same amount every year even if their account value ultimately falls to zero. Such a feature is typically not available in fixed income investments such as a CD or bond.

Historically, insurers have used the S&P 500 as the basis for indexed annuities, but the market is evolving. For clients who might benefit from added diversification within the annuity, there is an opportunity to draw on the results of more than one index. One illustration of this might be an annuity that credits interest through a blend of the changes in the traditional S&P 500 Index and, for example, the Dow Jones EURO STOXX 50(R) Index, which covers 50 companies from 12 European countries, or another index.

Indexed annuities may not be for everyone. As you know, they’re meant for individuals looking for a long-term investment for their retirement. Clearly, they also don’t provide the equity exposure of a variable annuity, which might be more appropriate for those with longer-term investment horizons. Conversely, they may offer upside over the predictable interest rates of fixed annuities and CDs. For clients who are willing to take on slightly more risk, indexed annuities may provide a satisfactory path to get out of the bond/CD rut to pursue greater interest and income opportunities.

Chad Tope is senior vice president and a registered representative of Directed Services, LLC. He can be reached at [email protected] or 515-698-6567.


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