Avoid Indexed Life Insurance Products
Everyone reading should know that I am an actuary, as well as a quant and a financial analyst. Math is my friend.
It's no secret that this year has been a volatile one for the markets. The S&P 500 is down 18% year to date, while the Nasdaq Composite is off by 27% year to date. Meanwhile, the VIX, a key measure of volatility, is up 49% year to date at 24.72. However, it has spiked as Read More
Math is not the friend of many of my readers, so I usually don’t bother them with the math. Tonight’s post will be no different. It stems from my time of creating investment strategies for what was at that time a leading indexed annuity seller.
What is the return that you get from an indexed annuity? It is the return from index options, subject to a certain minimum return over a 7-15 year period. Now, on average, what is the return you get from buying any fairly priced option? You get the return on T-bills plus zero to a slight negative percentage. So, if the option premiums paid are cumulatively greater than the guaranteed minimum return, the product should return more than the minimum on average — but likely not much more on average.
Why is that? Options are a zero sum game, and usually there is no inherent advantage to the buyer or seller. There are some exceptions to this rule, but it favors at-the money option sellers, never buyers. Buying options is what happens with indexed annuity products.
Now, over any short amount of time, like 5-10 years, you can get very different results than the likely average. That doesn’t affect my point. With games of chance, some get get good outcomes, and other get bad outcomes.
Now, the indexed life insurance products sellers will tell potential buyers that they will never lose money if the market goes down. True enough. What they don’t tell you is that over the long haul, you will most likely earn more investing in one of Vanguard’s S&P 500 funds or even their Balanced Index Fund. You may even earn more investing in their high yield fund, or even their bond market index fund.
In exchange for eliminating all negative volatility, you end up getting very