The reason people buy annuities has much to do with fear, right?
No matter how much I preach the gospel of investing and offer up illustrations of how a certain portfolio works — and how other portfolios would work about as well — investment professionals will sell variable annuities and insurance professionals will sell fixed indexed annuities.
If you are a fan of indexed investing (a method favored by Jack Bogle and the fund company he founded, Vanguard), you would have earned — had you invested in the S&P 500 from Jan. 1, 2000, through Dec. 31, 2012 — a negative rate of return of just under 2 percent. (That’s a cumulative 2 percent, not a yearly average, developed by me from Yahoo Finance’s S&P calculator.)
The point it this: taking $40,000 yearly from $1 million in SPY — the SPDR ETF that replicates the S&P — would have been a disaster during that time period. Even though one cannot tell exactly how much would be left — because of the sequence of returns — it is likely to be less than $520,000.
With an annuity, if one is dealing with a trusted, highly rated insurance company, the chances are good that the $40,000 may continue forever, no matter what. (Don’t get too excited about this concept; there is still risk. Highly rated insurers writing annuities have gone down the tubes before — you can probably even think of a few names. Please keep in mind that nothing is 100 percent certain.)
My estimate is that, with a thoughtful mutual fund or stock (or mutual funds and stock combined) portfolio, one has a pretty good shot — maybe as much as 90 percent — that a $1 million fund at the start will provide around $800,000 of income over its first 12 or so years, and that it will perform adequately and provide inflation-matching yearly income for 30 years or more. This is assuming that one does not sell when others are fearful; in other words, assuming that one does not exhibit herd investing behavior.
There are no guarantees, and the assumption is that the designer has some skill at portfolio building. If you think there have not been 20-year periods when the market (the S&P and/or the Dow) has returned modest average 3 percent or 4 percent yearly returns, think again; after inflation, the results are worse. A good place to examine bad periods, at least through 2007, is at this web site.