For conservative investors who are looking for good (safe) places for their money, bonds have been the gold standard for years. They offered a easy way to provide balance to any portfolio with protection from market volatility, as seen in the market drop in 2008. But the standards might be changing, and according to a recent Kiplinger article, bond investors might discover that even their investment vehicle of choice has a downside.
Interest rates have been exceptionally low for quite some time now, but it appears that they may be on the rise. If that’s the case, bonds can lose market value. When you buy a bond, you’re basically lending money to a company or government entity for a fixed term at a fixed interest rate. If your bond is paying a low interest rate but new bonds are being issued at a higher one, then it’s possible no one will want to buy your bond if you need to sell it before the maturity date. And so the price of your bond can fall, making it not as safe as you might have previously thought.
So where do you go from there? What other options provide reasonable safety and a decent return? One possible option is annuities. These financial products come in a variety of shapes and sizes, but there’s one in particular that can provide competitive interest credits without the interest-rate risk associated with bonds.
With one of these fixed-indexed annuities, an investor can take advantage of market-linked interest credits while receiving a steady income stream in retirement. These annuities are actually insurance products that are tied to a specific market index, allowing them to benefit from market gains while enjoying principal protection from downside risk.
Of course there are some drawbacks too. They often have a cap that limits your interest earnings. If the index’s return is negative, there is no loss posted to your account. If the index’s return is positive, interest is credited to your account, but with a cap.
Like with any financial product, it’s important to understand what you’re getting into before signing on the dotted line. Here are some important questions you should ask before buying a fixed indexed annuity:
- What is the guaranteed minimum interest rate?
- Which index will determine the amount of my interest credits?
- Will the interest credits be calculated annually, quarterly or for some other length of time?
- What are the surrender penalties and tax implication of an early exit from the contract?
- Will the insurance company have the right to lower the cap at some point in the future, and by how much?
Be sure to talk with your trusted financial and tax adviser(s) about how a fixed-index annuity might work in your portfolio.
Written by Rachel Summit