Are Annuities A Good Alternative To Bonds?

Not long ago, investors counted on government bonds to be the foundation of a stable retirement. For many years, bonds were the top choice of older, more conservative investors within a few years of retirement.

Now, though, the soon-to-be-retired, along with those already in retirement, seek alternatives to bonds. These seniors seek alternatives to bonds that can provide them with slow, steady growth without too much risk. Given the current low bond yields, there is an understandable movement away from government bonds.

Could annuities be an alternative to bonds?

Annuities are financial tools that provide guaranteed streams of predictable income when you no longer work. Wealth advisers inexperienced in the distribution phase of life are sometimes dismissive of annuities and other safe money products. Most of the time, that's because they don't understand how annuities work and what a powerful portfolio component they can be.

However, once a person discovers more about annuities, they usually want to include one in their retirement plan.

Can annuities help you achieve diversification in a turbulent economic environment?

Most investors understand that it's not a best practice to put all one's money in a single asset. On the other hand, the idea that one can balance one's portfolio through diversification may be a myth.

According to a 2018 report from Statista, a leading provider of market data, there were only 5,424 actively traded companies in the U.S. However, in that same year, there around 8,094 mutual funds.

When you think it, this means that over 8,000 funds were competing for the same 5,424 securities. There's bound to be some overlap. How can you know precisely in which of those 8,000 funds to place your cash?

The answer to that question, unfortunately, is often determined by what funds your employer offers in their 401(k) plan. Out of 8,000 funds, your employer plan will probably have, at most, 25 or 30 choices.

So, of over 5,000 traded companies and 8,000 different funds, you get only a handful of options with an employer plan. If you rely solely on an employer plan for your retirement, you will very likely sacrifice diversification and proper asset allocation.

Bonds might be a choice.

In the past, employees who wanted to shore up their employer-sponsored plans often turned to bonds. Treasury and municipal bonds have repeatedly proven to be a safer means of achieving growth while mitigating risk. However, bonds may become less than ideal if overall interest rates become volatile.

While they do have some risk, bonds are typically considered a safe money product. However, in our current zero-interest environment and record-high equities markets, bonds have lost some of their luster. Investors concerned about risk but needing gains are now looking for reasonably safe alternatives to bonds.

Could fixed-index annuities be the answer?

A fixed-index annuity (FIA) could be the solution for risk-averse retirees and retirees. In a FIA, you give your money to an insurance company that places those funds in a general fund. The annuity company then makes investments designed to provide the highest possible gains without unnecessary exposure to risk.

FIAs minimum interest guarantee means that your principal is protected from market volatility, something that is increasingly important as you plan for retirement. For those comfortable with Certificate of Deposit-like returns, indexed annuities could be an excellent addition to the "safe money" part of your portfolio.

However, you should be aware that an indexed annuity does not take full advantage of stock market gains. In most instances, you will not receive dividends, and something known as the "participation rate" can limit gains. On the plus side, though, you will still get a minimum guaranteed interest rate depending on your contract, even if there is a market downturn. These products have no exposure to market risk.

Summing it up: Before making any decisions with your wealth, you should consult a qualified retirement and income specialist. If you're considering adding annuities to your retirement mix, do your research first and talk to a safe money specialist who understands the product's pros and cons.