The Federal Reserve Chairman changed his stance last week and said inflation is not temporary and our monetary policy must change. Simply put, interest rates will rise over the next year as the government shrinks the money supply. If you think this comes down to a 6% CD rate point, I wouldn’t count on that.
High rates of return and no risk do not exist. The problem is that with age, our time horizon changes (when we need money). With a shorter time horizon, our ability to take risks decreases. When I say take risks, I mean investing in stocks.
At the same time, your time horizon is getting shorter, medical science has increased our life expectancy. You will need more money because you will live longer and need more long-term care.
So how do you get a better rate of return while minimizing your risk? There are several ways, but today I am going to explain the advantages of a variable annuity to you. A variable annuity has all the advantages of fixed annuities (deferred taxes, guaranteed income when switching to an annuity, capitalization or systematic investments). What is different is that instead of a fixed rate of return, you can choose to invest in a portfolio of stocks and bonds. At this point you should be asking yourself if I invest in stocks, how do I minimize my risk?
Traditionally, a variable annuity allowed you to minimize risk by choosing a portfolio of stocks over bonds that reflected your risk tolerance and time horizon. Sixty percent of your money would be in stocks, 40% in bonds, for example. As we get older, this ratio could change, 20% in stocks, 80% in bonds. While this strategy strives to minimize risk, it does not solve the problem of living longer and needing more money.
In an attempt to solve this problem, insurance companies, the only issuers of annuities, have developed new products. Remember, when I explained fixed annuities, the insurance company quarantined a rate of return so that the investment risk was borne by the insurance company. The same principle can be applied to a variable annuity. The insurance company can offer a guaranteed rate of return while still allowing you to stay invested in the market. If now you say it sounds too good to be true, understand that you will pay a price for it.
Unlike you, an insurance company has an infinite time horizon. They can stay invested in the market forever. With this understanding, if they guarantee you 4% while earning 6%, then they make money and you get higher return with lower risk.
The next question you should ask yourself is: What if I don’t live long? What happens to my money? If you have loved ones who are concerned about you, you can purchase, for a fee, a guaranteed death benefit based on either the money deposited or the amount accumulated.
Understand that this article explains the concept of reducing risk while staying invested in stocks. Each variable insurance company annuity has different characteristics and should be explained in detail. Variable annuities can also only be sold by persons authorized to sell securities and such persons must exercise a fiduciary responsibility to act in the best interests of you.