Are CDs Good Protection For The Bear Market_1

Post on: 13 Апрель, 2015 No Comment

Are CDs Good Protection For The Bear Market_1

The S&P 500 began the year at a level of 1469.25 and ended the year at 1320.28. The highest point was reached on 24 March when the index hit 1527.46; the lowest point was 1264.74 on 20 December. The index closed lower that its starting point on 187 days and higher on 65 days.

From a high of 6.75% last January the 30 year US Treasury bond yield trended down — with the exception of a second quarter burp, ending the year at 5.46%. Option volatility was nasty with the option volatility (VIX) index averaging 25.947 during the year. Volatility was exceptionally high last April reaching an average value of 31 during the technology stock rumbles, falling back to under 20 by the dog days of Summer, and then closing the year at levels that brought back memories of the Asian crisis of 1998.

Sales Success Story of the year — Midland National Life

Product Innovation of the yearConseco Annuity Assurance’s Simple Index

The players stayed pretty much the same. BMA, Life Investors and Monumental entered the market and SAFECO came back. Pekin Life left the arena. Two trends developed in 2000. A minor trend was carriers adding absolute or annual point-to-point crediting products to their portfolios of averaging structured offerings. A more significant trend was a number of carriers adding products with multiple indexes. The most significant sales success story of the year was Midland National Life. Midland National began selling index annuities in the fourth quarter of last year and was one of the top five sellers of product by the second quarter of this year. Conseco Annuity Assurance had the most significant product innovation with the introduction of their Conseco Simple Index annuity.

2000 began with a record $1.5 billion in first quarter index annuity sales. Sales dropped in the second and third quarters, and will undoubtedly be down in the fourth quarter resulting in estimated sales of around $5 billion for the year — in line with 1999. The decrease in sales was primarily due to very competitive fixed annuity rates coupled with an extremely volatile stock market.

With the exception of a few bond indexed products, and one monthly averaged Russell 2000 product, index annuity returns were zero for the calendar year. If you had purchased an index annuity in 1999 and ended your first contract year in 2000 your credited rate ranged from zero to as high as 15.48% depending upon the date you bought.

A consensus forecast of the nation’s leading economists, reported in Fortune’s 12/18/00 issue, said that short term interest rates will remain basically flat for most of the year and begin rising in the fourth quarter as growth increases. My crystal ball sees rates softening through the second quarter.

Index annuity sales are not going to increase until fixed rates retreat under 6%. Agents are correctly perceiving that fixed interest rates are very attractive from a historical perspective and are selling traditional fixed annuities. Although it would help index annuity sales if the stock market resumed an upward course, even this effect would be minimal as long as rates remain high.

The 2000 stock market should open the eyes of many investors and make them more aware of the risk of stock investments. After the stock shock has dissipated, and fixed rate alternatives are less attractive, these people may decide that an equity linked vehicle that protects their principal from market risk makes sense. However, index annuity sales will not advance until fixed rates go down a point from their high and I see this happening in the Spring of the year.

Annual Reset Index Annuities Reset Annually 1/01

Most of the index annuities on the market calculate index movement for a one year period and then credit interest to the index annuity contract applying a crediting formula to any recognized gain. If there isn’t a gain the contract simply credits zero for the year, but previous interest credited is unaffected. The process then begins again using the actual end of the year index value as the starting point for the coming year. This is the basic structure for annual reset index annuity products and it is easy to understand. However, the simplicity of the index annuity structure doesn’t portray the real power of the index annuity story.

The index annuity locks in the annual gain. The gain cannot be lost even if the index subsequently goes down. This is a very important feature. Equity investments have produced significantly higher returns over time than fixed rate vehicles. Based on the past performance of equity investments why doesn’t everyone buy stocks? The reason is that stocks can go down and you can lose money. Index annuities are designed to give the potential for higher returns than other savings vehicles, but without the market risk to principal associated with stocks. In today’s financial markets annual reset index annuities are crediting effective net rates of around 50% to 60% of the actual index gain. At first glance, participating in only around half of an index yearly gain seems low and unappealing — especially when compared to pure equity investments. However, you need to remember that these annuities ignore the bad years.

Suppose we had a five year period where the index acted like this:


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