Roger Ibbotson, best known as the founder of Ibbotson Associates, an asset allocation research firm, has published new research championing fixed indexed annuities as an alternative to bonds for investors approaching retirement.
Those investors usually increase their bond holdings to reduce risk in their portfolios, but doing so in the current low-yield environment means risking not having enough income in retirement along with reduced prospects for capital appreciation.
Fixed indexed annuities can offset those shortcomings: In addition to earnings that grow on a tax-deferred basis, they guarantee a set interest rate and provide exposure to stock market returns, which tend to be higher than bond market returns, according to Ibbotson’s white paper.
Their performance is linked to the performance of a stock market index, which is often but not always the S&P 500 — Nationwide’s New Heights Fixed Indexed Annuities offers the option of linking to a index from Zebra Capital Management, founded by Ibbotson, its chairman and chief investment officer — but the gains are limited because the insurance company bears the risk, and losses are not a factor.
For example, an FIA linked to the S&P 500 would collect just 6% of a 10% gain over three years but would not lose money if the S&P 500 lost 10% during that time period.
“The downside protection is very powerful and attractive to many individuals planning for retirement,” writes Ibbotson in his report.
He simulated the performance of $1 invested in an uncapped large-cap equity index FIA compared to the performance of long-term government bonds over the period from 1927 through 2016, net of expenses. He assumed annual expenses of 10 basis points for a passive stock portfolio and 10 basis points for a passive bond portfolio.
The hypothetical maximum annualized return for the FIA was 5.81% compared with 9.92% for large-cap stocks and 5.32% for long-term government bonds.
The maximum annualized return for a three-year holding period of the FIA was 27.56% versus 30.76% for large cap stocks and 23.3% for long-term government bonds. The minimum annualized three-year return of the FIA was zero compared with a 27% loss for large-cap stocks and 2.32% loss for long-term government bonds.
Ibbotson also compared the performance of a 60/40 stock/bond portfolio to that of portfolios with 60% stocks, 20% bonds and 20% FIAs — and 60% stocks 40% FIAs — over the same 1927-2016 period.