SAVE   |   EMAIL   |   PRINT   |   RSS  
Downsides of equity indexed annuities
A diversified portfolio of stocks and bonds offers better protection from market downturns.
December 13, 2005: 12:29 PM EST
By Walter Updegrave, CNNMoney.com contributing columnist

Sign up for the Ask the Expert e-mail newsletter
INVESTOR RESEARCH CENTER INVESTOR RESEARCH CENTER upgrades & downgrades earnings & warnings public offerings INVESTOR RESEARCH CENTER INVESTOR RESEARCH CENTER
More information on Updegrave's new book.

NEW YORK (CNNMoney.com) - I recently moved some money into what I believe is called an equity indexed annuity.

I understand that this type of annuity protects my principal, although the interest rate I get is lower than it would be without this capital protection. Do you think I made a good choice?

-- Monroe Howell, Savannah, Missouri

I'm not a fan of equity indexed annuities or, for that matter, new CDs that work much the same way.

For one thing, they come in so many different versions with the returns based on so many different formulas that it can be very difficult for the average person to understand just what the heck they're getting, let alone figure out and under what conditions which version will do better than others.

I also think that, in general, these types of investments give investors the impression they'll be getting more upside than they really have a shot at and that they hype the value of the downside protection.

Finally, even if capital preservation is important to you, I think these annuities are an expensive way to get principal protection, in large part because of the big commissions many of them provide to the people who sell them.

I believe you can get comparable downside protection and more upside potential by building a diversified portfolio of stocks and bonds.

I laid out my position on these annuities and similar products in a recent issue of MONEY in my column, The Long View, which you can read by clicking here.

After that column appeared, I got a lot of feedback from angry sellers of indexed annuities, who accused me of missing the main point about these investments -- namely, that they provide a high degree of safety that many investors, particularly older ones, crave.

I agree that this is true. But unless you're going to keep all your assets in one investment (a strategy that would make little sense), then focusing on the riskiness of each individual asset you own is the wrong way to think of security.

The right way is to look at your investment portfolio overall, and how different assets act in concert with each other.

What's more, you've got to think not just of capital protection, but the potential for growth as well. And when you view safety in this context, I think it's pretty clear that you can get the protection you need plus better growth potential from a diversified portfolio rather than an indexed annuity.

Does that mean I can't envision some circumstance where someone might be better off in an indexed annuity? Of course not. If I knew the stock market were going to lose 50 percent of its value tomorrow, putting my money into an indexed annuity might make sense.

The point is, though, that you don't know this. And investing today as if Armageddon will come tomorrow makes no sense -- especially since you can create a portfolio that will give you enough security to protect you sufficiently against market downturns, yet give you a better shot at long-term gains.

The only other instance in which I could see these annuities making sense is if you have such a small amount of money that you can't afford to build a diversified portfolio and you're absolutely terrified of any temporary loss of principal.

But even then I'd warn you that you've got to be very careful before signing up for these products because they often levy onerous early withdrawal penalties if you decide to cash out within a few years of buying them.

But, hey, that's just me. For those of you out there who find the downside protection so tempting that you're ready to buy an indexed annuity or similar vehicle, you'll have no trouble finding someone to sell one to you.

Before you buy, though, I recommend that you read the fine print in the contract very thoroughly to be sure you know just what you're getting into. I also suggest you read the Investor Alert the NASD released on equity indexed annuities earlier this year.

If you still want to put your money into an indexed annuity or similar product after doing that, well, I may not agree with your decision, but I certainly wish you the best of luck.

------------------

Walter Updegrave is a senior editor at MONEY Magazine and is the author of "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

For all the latest headlines in Ask the Expert, click here.  Top of page



YOUR E-MAIL ALERTS
Follow the news that matters to you. Create your own alert to be notified on topics you're interested in.

Or, visit Popular Alerts for suggestions.
Manage alerts | What is this?