Ground Breaking Study Showing FIAs Outperforming Bonds 98% of the Time over the Past 25 Years

Troy Sharpe: Today I’m going to share with you a groundbreaking study that shows over the past 25 years, a certain type of fixed indexed annuity has outperformed bonds 98% of the time. We’re also going to talk about what this means for your retirement, not just in the context of today, but over the next 10 years looking at forecasts, the current rate environment, and how that impacts the growth potential that’ll put you in a better position to make a good decision of whether these tools could be appropriate for a portion of your retirement.

Hi, I’m Troy Sharpe, CEO of Oak Harvest Financial Group, Certified Financial Planner professional, host to The Retirement Income Show, and also a certified tax specialist. As we close out this educational series on annuities and fixed indexed annuities, the study that came across my desk by Barclays recently, it couldn’t be more perfect timing because what it does is it compares the performance of a certain type of fixed indexed annuity, one that has what we call a volatility controlled index which I’ve covered in this annuity series, to bonds and the performance of those two asset classes over the past 25 years.

This groundbreaking study is important for you because it really shines the light on the performance of this asset class and helps to give you some insight as to its viability if you’re considering adding an annuity to your portfolio, either for safe growth or for lifetime income or possibly some of the long-term care benefits that some of these strategies can provide.

Now, just a quick refresher. Fixed indexed annuities are not designed to replace your stocks. Just because they track the stock market with 100% principal protection, and they give the opportunity for reasonable growth over time, it doesn’t mean they should be considered stock market replacements. For that long-term growth part of your portfolio, you absolutely should still consider stocks for long-term capital appreciation. For that secure part of your portfolio, the sleep at night money, the money that you want to be there no matter if the stock market’s going up or going down, the fixed index annuity can be a viable asset class for those monies.

Not only do you have principal protection, but you have options for guaranteed lifetime income or paychecks that are deposited monthly into your account or you and your spouse’s account as long as you’re alive, as well as long-term care benefits and other features that some of these products have. Now, where they can be considered as part of an overall investment allocation as a replacement for some of those bonds inside your portfolio or CDs, or other asset classes that have similar risk characteristics or you consider to be low risk as an alternative to something with 100% safety of principal but also the potential for double-digit returns in any given year.

They’re designed to average the best growth, growing somewhere between 4% to 6% over time, but most importantly, you’re never going to lose money. If they underperform, you might do 3%, if they overperform, you might average 6% or 7%. Somewhere in that range, you can feel comfortable knowing if you add this asset class and you have a good contract with good terms and conditions that you do have good potential to earn a very reasonable rate of return with 100% safety of principal.

We’re going to post a link to this study in the description down below. For those of you who want to take the time to go through and read it, it is written and fairly easy-to-understand language. It’s not a 42-page mathematical paper, but it is very comprehensive and they do a good job conveying the results from the data analysis, so we’re going to have that in the description if you’d like to read it.

Today’s video, I’m going to go through the highlights and really point out the most impactful parts of this study. First and foremost, it starts out saying, “The innovation in the fixed indexed annuity space has markedly improved the offering and this provides a very important distinction to bonds. We find that examples of this innovation in FIAs have outperformed bonds on a consistent basis over the last 25 years.”

The problem with bonds in today’s environment is that when interest rates go up, your bond values typically go down, so you are not principal-protected. Now, if you own bonds and you hold it for 10 years or 20 years or 30 years until they mature, as long as that institution is in business, you will get your money back. That’s how a bond works. In the meantime, they have market value fluctuations. Your fixed indexed annuities do not have those market value fluctuations, you’re 100% protected from those downside movements.

As we get down to Page 2 in this study, they put a very nice chart together showing the performance of the underlying components of the study. They look at the S&P 500, Single A bonds, so these are going to be corporate bonds, US treasuries in the 7 to 10-year range, and then what they call a Risk Parity 5% VC, the VC stands for volatility-control.

What a volatility-controlled index is, is that automatically based on some preset formula determined by volatility in the markets, the index that you track, when you think of index, think of S&P 500 or the Nasdaq, you have tons of indexes in the universe. What these volatility-controlled indexes are designed to do is that when volatility gets high, they shift out of stocks and then to either more cash or bonds typically, and when volatility is low, they shift automatically from bonds into more stocks. They’re not designed to give you home runs. You’re not supposed to average 15% or 20% a year or even make those types of returns in a single year. What they are designed to do is to consistently put you in between 4%, 5%, 6% rate of return expectation without principal risk, without the concern of losing your principal.

The dark line is the S&P 500 here, obviously, over the 25-year period it has outperformed, but when we compare Single A Bonds and US Treasuries to Risk Parity 5% volatility-controlled index according to this study, we see that the VC index, the Risk Parity, the FIA has significantly outperformed not just treasuries but also corporate bonds.

Corporate bonds typically have more risk or they do have more risk because if the corporation defaults, you lose your money in the bond. The US Government is much more secure than your A-rated corporation. It is an interesting analysis here also that the long-term performance of Treasuries and Single A bonds are fairly similar over long periods of time here.

Now, I want to jump right to the meat of the analysis. Here we have the average rolling seven-year return. The best seven-year return and the worst seven-year return. This assumes that the surrender charge on the fixed index annuity is a seven-year period. Now, remember back from the previous videos that we went through, typically the longer the surrender charge period, the higher your opportunity for growth is.

That’s pretty standard across the board. If you have a shorter surrender charge period, that means your money becomes 100% liquid more quickly, but you’re sacrificing the potential for growth. Typically what we call your participation rates are lower. These are uncapped fixed index annuities. Big myth out there, fixed index annuities put a cap on your returns.

Some, what we call crediting methods, will put a cap on your returns. Today those caps are around 6%, 7%, 8%, even 9%, but I recommend for most people to go into the option, the credit method that gives you an uncapped opportunity. It doesn’t mean you’re going to make 30% every year but having that uncapped opportunity doesn’t limit your returns.

There is a reasoning for maybe diversifying your crediting methods, but we talked about that in the previous videos. Just to give you some understanding of the study itself if you’re not going to take the time to read through everything. Then we have four different columns over here. The first one looks at an S&P 500, an uncapped index with only a 25% participation rate.

Participation rates today in the industry are somewhere between 40% to 60%. Whatever we see here, this is actually much lower than what we would expect in today’s market environment, but that’s what the study did the analysis on. The S&P 500 cap here, they assume you chose a capped method and had only a 4% cap. Again, a conservative analysis because today caps are much higher than the past 25 years and the data that they chose to select as far as analyzing in this study.

Then we have the Risk Parity volatility controlled index and then we have Single A bonds over here. Again Single A bonds have more risk than government bonds. We would expect over time that single A should perform better. We call that the risk premium. If you’re taking more risk, you should expect to have a higher return over time in government bonds.

Here are the results, your average return annualized, per year for the three methods in the FIA right here. Then here’s your average return for your Single A rated bonds. Your best single one-year return up to 13.5% for the volatility-controlled index, and then your worst annualized return here, 3.82 for the volatility-controlled index compared to 1.8 for your Single A bonds.

When we look at over a seven-year period and we have to look in longer periods of retirement because we’re constructing an investment allocation, we’re not doing it for the next six months or three months, we’re doing it to achieve your objectives over long periods of time. We want to understand the relative performance or comparative performance of various asset classes that are a lower risk that we can choose from.

This doesn’t mean you completely avoid bonds. Bonds absolutely can still play a role in an investment plan, but what it does is gives us some very clear numbers to start to understand, do fixed index annuities as an asset class possibly have a place in my portfolio? Can I expect to archive a certain level of return? How consistent is that return, and is this an alternative to bonds and CDs for you and your retirement?

Down here at the very bottom, the percent of times the returns outperform Single A bonds, 45% for the participation rate at only a 25% participation rate, 40% with a 4% cap, and then 98% of the time with the volatility controlled index. Now it is important to point out, with participation rates in today’s market and cap rates in today’s market, much higher than the analysis done in this study, these numbers we would expect to all be significantly higher as well when compared to the bond portfolio.

Today, you can get 40%, 50%, even 60% participation at the time of recording this video with an uncapped S&P 500 tracking, and with the capped option, if you chose to go that way, you’re looking at right now, 6%, 7%, 8% on S&P 500 caps if you choose to have a capped crediting method. Again, I recommend an untapped crediting method for most people, but there is a reason why they exist. You do have that choice. You can diversify your crediting options.

Again, the main takeaway here is simply the fixed index annuity can be considered a viable alternative to bonds when we’re talking about safe growth. This study does nothing to look at the benefits, the security that come to the table when we look at the guaranteed lifetime income options or the long-term care benefits that are available in some of these contracts, just simply focusing on the accumulation potential relative to the safety of the asset.
Now, a couple of conclusions with the study here, and then we’re going to jump to a forecast looking forward over the next 10 years to give you some context of not just the past 25 years because past performance isn’t indicative of future results, but we want to start to look at potential factors and how that can change the scenario for you and your retirement when we consider these tools as a replacement for bonds or CDs possibly, so we have that context.

Risk factors to fixed indexed annuities. First and foremost, you don’t ever want to put all of your money into these tools. They are meant for long-term accumulation. In exchange for principal protection and the opportunity for reasonable growth over time, you have to give up liquidity. Most of these contracts are going to allow you to access up to 10% of your account value per year.

If you put in $250,000, you can get out $25,000. The next year, if you need to get 10% of the account value, you can get 10% out every year for as long as that surrender charge is in place. After that surrender charge period is over, your money’s 100% liquid, you can do with it as you please. If you pass away at any time during the surrender charge period, you are not incurred surrender charges, so no fees, no penalties there.

The big downside is really you have to look at them as longer-term investments. Typically you’re going to get 10% annual liquidity. Now, the second risk factor here in how they did the calculation with the fixed index annuity returns is they include a 2% per year charge from the insurance carrier. It’s important to point out that the 2% fee, it’s not a fee that’s charged to your account. Essentially, it accounts for the insurance company’s expense to manage the policy, to build the structure that allows you to have principal protection and also upside potential linked to the stock market performance, but as well as a profitability margin built in there.

The 2% is not charged to you. What it is that’s built to what we call the product pricing. If you have a 100% participation rate or 150% or 70%, that is the rate that’s being offered. The insurance company comes up with those rates after they figure out how much it costs for them to administer the product and also to have a profit margin. Typically, the profit margin on these are somewhere around about 1%.

The study looks at the cost associated with the insurance carriers to administer and also service the contracts and that’s at 2% per year. Now, the big conclusion down here, we assess that fixed indexed annuities provide policyholders with prepackaged bonds that are professionally managed by sophisticated insurance companies, combined with upside linked to equity markets that are less exposed to inflation than bonds.

It’s very difficult to determine if you’re building a portfolio to have some type of expectation moving forward, that when the stocks go down, that your bonds are going to go up. That would be what we call a negative correlation. When they move in tandem, that’s positively correlated. Bond markets are extremely fickle. When we look at economic policy, we look at monetary policy, we look at investor appetite for risk, a lot of times investors are more risk on than risk-off, all of these factors and hundreds more are intertwined into how a bond is actually valued on a day-to-day or year-to-year basis. It’s impossible to predict those. We do know there are long periods of time in this country where stocks and bonds are positively correlated, meaning they move in tandem. We also know there are also long periods of time in this country where stocks and bonds have been negatively correlated, but the ability to predict what’s going to happen over the next 10 years is very, very difficult in regards to that correlation. We have seen the past several years though, stocks and bonds move in tandem.

Now looking forward into the future, even though we can’t predict that correlation, what I do want to do is look at the 60/40 portfolio, which if many of you have listened to me for a long time, you know I feel that this is very antiquated in today’s times for many reasons, which I won’t go into all of them today. We want to look at the typical 60/40 portfolio, if you just go stocks and bonds, but then also I want to look at a consensus of expert Wall Street opinions over stocks and bonds and how these experts expect those two asset classes to perform moving forward.

Here we have a really good chart put out by Lincoln Investment Advisors that came into my inbox recently. This is over the past going back to 1976 to 2021, your 60/40 portfolio has returned on average 10.9%. That is really good. We would love if we could go 60% stock, 40% bonds, and make 10% a year. I want to point out a few key things before we get into the consensus for this portfolio moving forward.

First and foremost, we know as interest rates go up, bonds go down. If we look here, the dark color is bond performance, its attribution to this 10.9% average return on an annualized basis, then the orange is the equity, US stock returns its attribution to this average return. We see here in 1977, 1978, 1979, 1980, where the bond attribution to the average return was very, very minimal.

If we look here at this chart, so this is a chart of interest rates on the 10-year treasury, we look here, 1977, 1978, 1979, 1980, interest rates were going up. As interest rates were going up, bonds performed very poorly. Then over the next– as you’re all well aware, interest rates have come down over the past 30-some years. That’s where the average return we see bonds making up a larger and larger proportion of the overall average return. It’s because as interest rates have come down, the value of bonds have gone up. That’s been what we’ve experienced in this country over the past 40 years, roughly.

Now I want to show you what experts, Wall Street experts expect that 60/40 stock bond portfolio, how they’re expected to perform over the next 10 years. Here we go. This is from 1976 to 2021, an average of 10.9% per year for that portfolio. Moving forward over the next 10 years, according to JP Morgan, Goldman Sachs, BlackRock, and State Street, an average of this combined 60/40 portfolio, 4.5%. That’s primarily because the bond portion, if we look at the next 10-year average return forecast from bonds from these large institutions, it’s very, very, very low. It ranges from 1.1% per year to about 2.8% per year.

It’s very likely we’re going to have inflation above those expected bond returns. Here’s something else to note. When it comes to forecasting, these large institutions, they’re not great at the stock market, but they are highly, highly accurate historically speaking when it comes to forecasting bond returns. The average US stock market return, take it for what it’s worth. 6.14% from these institutions on average, ranging from 5.16% at JP Morgan to 7.4% at Goldman. Then again on the bonds over here, we’re looking at an average of about 2% expected performance.

My question to you is, why would you want to have 40% potentially more of your retirement assets in an asset class that is expected to perform pretty poorly, possibly not even keep up with inflation over the next 10 years? This is where the fixed-indexed annuity alternative comes in. Maybe it’s a 60/20/20 portfolio for you, maybe it’s 60-some other percentage. The point is we should be considering adding other asset classes, one, because we have the opportunity for multiple streams of income, but primarily we want to diversify away from bond risk.

Again, it doesn’t mean that all bonds are bad and you should avoid them, but you should be educated and understand the circumstance that we’re in. When we start to look at replacing possibly a portion of the bond portfolio with an asset class that over the past 25 years, when bonds have done great, outperformed according to the study of these bonds, with all of this information, and we know that according to that study, the fixed indexed annuities with the volatility controlled index have outperformed 98% of the time those bonds in a period when bonds did really, really well.

When we look forward over the next 10-20 years, if interest rates continue to rise and bonds perform poorly, how do you think the fixed indexed annuity in that type of environment will compare to bonds? Most likely it’s a reasonable guess, but it’s educated based on everything we went through today, it’s not too far off to assume fixed indexed annuities could significantly outperform bonds over that same timeframe.

Considering them as a viable alternative to bonds makes a lot of sense for those people who want principal protection. Don’t worry about the fluctuations and also the opportunity for reasonable growth over time that can quite likely or possibly outperform the forecast for bonds.

We’ve covered a ton of content in this video, if you need to go back and re-watch it, I encourage you to. We did put that study that we talked about, the Barclays study. It’s in the description down below. If you haven’t watched the rest of the videos in this educational series about annuities, I encourage you go back and watch them. We’re going to have a link to those videos on a card at the end of this, and if you’ve tuned into all of these videos, I want to sincerely thank you. This means that you are far more educated than your peers, probably more educated than a lot of financial advisors out there, and you are in the driver’s seat to identify which products or strategies could possibly fit into a customized retirement plan for you.