Some index annuity bashers have suggested that people can do the same thing an index annuity does by putting most of their money in a long-term certificate of deposit and the rest in an index fund. The reasoning is because you’re getting all of the upside participation in the index — plus reinvested dividends — this gives you a better return than buying an index annuity with caps. OK, let’s see how that combo idea is working for you.
When this article was written, the average five-year CD rate was 1.63 percent. That means you’d need to put $9,223 in the CD to guarantee $10,000 in five years, leaving $777 to invest in the index fund. If the index fund doubled in value in the next five years, you’d have $1,554.
Adding the index fund value of $1,554 to the $10,000 value from the matured CD gives us $11,554 — or the equivalent of an 11.6 percent participation rate on our original $10,000. Using the CD/fund combo idea in a period where the index fund doubles nets an 11.6 percent total return on original principal.
Now let’s see how you would have fared with this CD-index fund combo in recent times versus actual index annuity returns: The rates on five-year CDs at the start of three consecutive Octobers were 3 percent in 2003, 3.4 percent in 2004 and 3.8 percent in 2005. These low rates mean there wasn’t a lot of money left over to put in the index fund after buying the CD.