How An FIA Can Replace Bonds As Your Hedge Against Volatile Rates
Interest rates heading to zero or below in the United States, following the pattern set in Europe and Japan, will only make it harder for most nest eggs to do their job. They could also foreshadow low returns across most major asset classes, making both wealth accumulation and retirement-income generation harder to achieve. With the bellwether 10-year Treasury note bouncing around 1.5% and the 30-year Treasury bond hitting all-time lows under 2%, all fixed income yields are expected to trend lower. If governments and high-grade corporates start paying little if any interest, they will contribute less and less cash flow to a “balanced” retirement portfolio.
On the other hand, were rates ever to normalize, longer-dated bonds would suffer a capital loss, undermining the other role in Wall Street’s policy portfolio played by bonds as a counterbalance to the volatility of stocks.
Keep in mind that the shrinking 10-year rate is also the key metric for appraising asset value and risk. Zero and/or negative rates may initially boost asset values, but longer term, the next round(s) of rate reductions may trigger a major reset in equity, bond, and real estate values, already considered on some measures to be inflated.
A strong argument can be made that retirement investors are living through a systemic paradigm shift and that the resulting uncertainty should focus them on the potential utility of hedging. Recent academic research agrees that investors in or near retirement can benefit from reallocating their nest eggs not between stocks and bonds but by integrating equities with longevity insurance.
Today, the Fixed Index Annuity (FIA) stands out as a rapidly evolving form of longevity insurance designed to anchor a retirement portfolio. Independent research, most notably under the auspices of Yale School of Management Professor of Finance Emeritus Roger lbboston, makes the case that the right FIAs can complement or even replace bonds in the nest egg, adding as much as 1 % to 2% of excess annual return – or even more in a low-rate environment. Add to that excess return the 1 % to 2% a year that actuarial science can contribute in the form of “mortality credits” and we can start to breathe a little easier.
Long-term pros may outweigh the cons
It’s important to note that the FIA is complex and has been characterized as such by the Securities and Exchange Commission, the National Association of Insurance Commissioners, and the Financial Industry Regulatory Association. Any guarantees are backed solely by the financial strength and claims-paying ability of the issuing company and the instrument offers varying levels of access during a gated surrender-charge period. Thus FINRA rightly stresses that investors do their due diligence when choosing among advisors before deciding whether a certain FIA is right for you.
The effort may well be worth it. Emphasizing downside protection, the FIA aspires to deliver steady mid-single-digit returns -without exposing the policy’s accumulated value to market volatility.
Because FIA performance is linked to a market index stripped of its downside risk, Wall Street’s risk-return formula trades off some of the index’s upside potential.
Those trade-offs take the form of caps and participation rates quantified by the investment banks serving as an insurer’s counter-parties. Accepting less upside to avoid market losses and stabilize returns is the price investors have always paid to hedge, and it’s up to each of us to judge whether it’s a price worth paying in the FIA.
Nahum Daniels is the founder and chief investment officer of Integrated Retirement Advisors, LLC., a Registered Investment Advisor in the State of Connecticut. He is the author of Retire Reset!: What You Need to Know and Your Financial Advisor May Not Be Telling You. A Certified Financial Planner and Retirement Income Certified Professional, Daniels has served mature investors for over 30 years.