Anytime people invest or save their money it is exposed to some type of risk that could adversely affect its future value. It doesn’t matter whether it is put into the stock market or a savings account, your money can come under assault if you are not aware of the different types of risk. While no single savings or investment vehicle is completely invulnerable, some do provide greater protection against the various forms of risk than others. Here we explore the use of annuities to mitigate all risk.
Different Types of Risk
When people think of risk they tend to think of market risk which is the possibility that they would receive back less than what they put in. The most obvious place in which you can lose money is the stock market, or, for that matter, any market in which prices fluctuate, such as the real estate market, the bond market or the precious metals market. Each of these have inherent in them varying degrees of risk. And within each market, there are different segments with varying degrees of risk associated with them.
The one mitigating factor that makes market risk less risky than people think, is that, in order to actually realize a loss, the investment has to be sold. Just because the value of an investment declines, doesn’t mean you will incur a loss. If it is held, there is always the possibility that the price will recover and even increase to where there is a gain.
The Risk of Inflation
Over the long term, inflation can pose an even greater risk than the possibility of market losses. The prices of stocks and real estate have always trended up, so, if investors can endure the natural market cycles, the chances are their investment will increase in value over time. If, however, you are investing your money to avoid market risk by putting into low yielding fixed vehicles such as savings accounts, your money is almost guaranteed to lose value due to inflation.
The Risk of Taxation
Taxes are a certainty, and they can contribute to slow and steady erosion of assets and income over time. For people in the higher tax brackets, a 10% gain on their investments is abruptly reduced to a 7% gain if it is subject to taxes. That difference of 3% over a long time horizon can translate into thousands of dollars lost. With the many tax advantages that are available to investors through the tax code, there is very little preventing them from minimizing the risk of taxation.
Some investments or savings vehicles are less liquid than others. Everyone should have a certain portion of their assets always available to them in the case of emergencies or should their financial objectives suddenly change. Before tying your money up into a five year CD, for example, it is important to know that you have access to other savings or investments for your current use. Although mutual funds and stock and bond investments are marketable, meaning they can be converted to cash quickly, investors who are holding any of these securities at a loss, may be reluctant to sell them, so there is some liquidity risk.
Reducing Risk with Annuities
The best way to reduce risk is to create a well-balanced, diversified portfolio of investments with a mix of assets that can offset the risks associated with a single type of investment. This will have the effect of stabilizing your returns so that they are not subject to the fluctuations of any one investment. As an example, stocks will help combat inflation, and bonds are needed to counter the movements of stocks. And, certain types of stocks perform well when other types don’t, so having both types in a portfolio will create more stability.
In addition to building a balance portfolio, investors might want to consider adding annuities as a foundation that can enhance stability and provide more guarantees of future growth, less taxation, and income security. So, when all heck is breaking lose in the rest of the portfolio, the annuities will continue to keep a portion of your assets moving forward.
How Annuities Reduce all types of Risk
Minimum Rate Guarantees
Most annuities include some sort of minimum rate guarantee so that, no matter the market conditions, your money will always grow. Even variable annuities, in which the accounts are invested in the stock and bond markets, include an option that will provide a minimum rate floor. Indexed annuities, in which the rate or return is linked to a stock index, not only have a minimum rate guarantee, the account values are reset each year to lock in the prior year’s gain. In essence, you can’t lose your principle.
Two types of annuities offer investors the opportunity to earn returns that can outpace inflation. Variable annuities invest in stocks, bonds and real estate. Indexed annuities generate returns based on the performance of the stock indexes. Most immediate annuities, annuities that generate a guaranteed income, include an option that ties the income payment to an inflation index.
The earnings generated inside annuity accounts are not taxed until they are withdrawn at retirement. And, if the annuity accounts are then converted into a guaranteed income stream, the taxes are deferred even further until the earnings are received over time in income payments.
Annuities should be purchased as long term investments, however, they do allow for access to the account values at any time. One withdrawal can be made from annuity accounts each year, and, as long as it doesn’t exceed 10% of the account value, there is no charge. Any withdrawal can result in the reduction of principle. Also, early withdrawals may be subject to a 10% IRS penalty.
A sound investment strategy should account for the many different types of risk. Allocating assets for optimum balance and diversification is the best way to achieve long term, stable growth. For added stability and a measure of security, annuities can form the ideal foundation for a long term investment portfolio.