Two Ways to Reduce Risk if the Bull Market Has Skewed Your Asset Allocation

By Ken Nuss

In the current bull market, many people have made so much money they now find their asset allocation is out of kilter. People who planned to put, say, 55 percent of their money in stocks may find they’re now 75 percent in equities.

A bear market could wreak havoc on both portfolios and the psyches of investors, who’ve gotten used to an unstoppable stock market for eight years. That’s why financial experts agree it’s important to rebalance periodically. It’s especially crucial for retirees and near-retirees.

If you want to move some of your money out of stocks, what are the pros and cons of various alternatives?

Money market funds are safe and liquid but pay little interest. Certificates of deposit are FDIC-insured but somewhat illiquid and pay modest yields. Bond funds are liquid and convenient, but short-term funds also pay modest yields. Longer-term funds pay more but their share prices are vulnerable to interest-rate hikes.

Fixed annuities are often overlooked. They offer a proven way to lower your risk. As well as guaranteeing your principal, they can cut your taxes and boost your yield.

Annuities do have limited liquidity, however, so they’re best for savers who can hold them to maturity, usually three to 10 years, depending on the contract, he says.

There are two main choices: fixed-rate annuities and fixed indexed annuities. Both lower your risk profile because both protect your principal. Fixed-rate annuities are straightforward while fixed index annuities are more complex but offer more potential upside.

Fixed-rate annuities are similar to CDs but pay more

A fixed-rate annuity is much like a CD: it pays a guaranteed rate for a set number of years. But an annuity has two key advantages: tax deferral (when held in a taxable nonqualified account) and most often a markedly higher rate than a CD with a similar term.

And they’ve gotten more appealing because rates have risen a bit in 2017. You can now earn up to 3.30 percent for a seven-year annuity, up to 3.15 percent for a five-year contract, and up to 2.10 percent for a three-year annuity, according to AnnuityAdvantage’s database of 290 fixed-rate annuities from 35 insurers.

Annuities are issued and guaranteed by insurance companies, so it’s important to choose a financially strong company.

Once the term is up, the owner has many choices, including rolling over the money into another annuity and continuing to defer taxes. “You can also choose to annuitize the contract to create a stream of income guaranteed for life,” he says.

Fixed indexed annuities: guaranteed principal plus upside potential

While many people are worried about downside risk, they equally don’t want to miss out on potential stock market gains. A fixed indexed annuity can meet both concerns.

You can have part of your cake and eat it too.

The product gets its name because the rate of interest it pays annually is based on the changes to a market index, such as the Dow Jones Industrial Average or S&P 500. Interest is credited when the index value increases.

The big advantage is that when the market falls, you lose nothing. Even if there’s a 2008-09-style crash, you won’t lose a cent.

In exchange for guaranteed principal, you’ll typically get only part of the market’s gains as an interest credit. You can shelter some of your money from market risk without locking in a lower fixed interest rate.

Because several different indexing methods may be available in one policy, with most companies offering annual reallocation windows, it takes some thought to select which method(s) to choose.

You won’t know the interest rate you’ll earn until the index or indexes have completed their measuring period. Usually, this is annually, but some annuities won’t credit earnings till the end of two or three years or more. The minimum interest rate is usually zero, so there may be years when you earn no interest.

When you’re rebalancing to reduce risk, make sure you consider all your money, in both taxable and retirement accounts.

While most people think of using fixed of fixed index annuities only for taxable (nonqualified) money, they’re also a compelling choice for a portion of your IRA or Roth IRA money.

While the tax-deferral feature doesn’t apply to a retirement account, which is already tax-deferred, a fixed annuity still has the benefits of guaranteed principal and a higher yield than a CD or most other fixed-income options.

Annuity expert Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed-rate, fixed-indexed and immediate-income annuities. He launched the AnnuityAdvantage website in 1999 to help people looking for their best options in principal-protected annuities. More information is available from the Medford, Oregon, based company at https://www.annuityadvantage.com.