inflation risk

How Annuities Mitigate Inflation Risk

money-bill-inflationInflation is the gradual erosion of the purchasing power of your dollar.  Inflation has averaged about 3.3% per year from the start of the US Government data set in 1910 to today- this includes the galloping years in the 1970’s. Check out the Government’s own Inflation Calculator HERE:

Now, I’ll be clear, an annuity itself will not protect you from inflation.

What an annuity CAN do, however, is increase your overall safety AND simultaneously allow you to invest more aggressively.  Let me explain…

How A Flooring Strategy Helps:

One of the primary benefits of ‘flooring’ your income with a guaranteed annuity is that you can invest the rest of your assets for more growth.

It is growth, and exposure to assets that are resilient and increase in value with inflation, that will protect you in the long run.

So here’s the thing- how can you have exposure to ‘risky’ growth assets while safely protecting your nestegg? It’s actually quite simple….

By allocating a PORTION of you assets to be dedicated to guaranteed income in an annuity, you free up the REST of your assets to be safely invested for growth!

If you are protecting one pile of money, and simultaneously trying to make it grow AND be safe AND produce income, all at the same time (traditional asset management and systematic withdrawals), you are running a grave risk.

Because of the competing priorities, the performance of that one pile of money trying to perform well on each of these different fronts will be compromised.  Your money is divided, and you’ll be conquered

Instead, by allocating a portion for income in an annuity, and allocating a different portion to growth, the growth portion can simply grow…. without pressure to sell in a down market for income… and without pressure to be conservatively allocated for safety….

This gets to the heart of our approach, namely, to put yourself in a position of strength by building a floor level of guaranteed income to cover your essential expenses.  Then the rest of your assets can be more aggressively invested, yet your overall risk profile is quite safe.

It just makes sense.

Conventional “Wisdom”

Wall Street’s usual recommendation is to be increasingly weighted to bonds as you get older, for safety and income.

Following this poor advice, not only are your assets at grave risk of loss due to interest rate rises, but you are likely NOT invested in assets that can jump with inflation, such as equities, metals, or real estate.

You could be stuck nursing an overweighed conservative portfolio in an inflationary environment, losing purchasing power, yet not be able to allocate to growth for fears of volatility or loss.

Following the ‘Thundering Herd’ and conventional wisdom, you’ll get trampled to death.

Inflation Risk Summary

Inflation needs to be recognized, and many people shy away from annuities due to inflation fears.

However, a guaranteed income from an annuity actually frees your remainder assets to be invested for growth and inflation protection WITHOUT the pressures of safety and income on those remainder assets.

Therefore, guaranteed income from an annuity is actually a critical component of an optimal inflation protection strategy.

6 replies
  1. roy dillow
    roy dillow says:

    Good article on Annuities as a floor/security. Couple of points which may be “pithy”.

    Returns from annuities can be reinvested in higher returning vehicles as inflation raises – essentially a “ladder of bonds” equivalent.

    Also, more impactful if one could set up a simple example i.e. 50% invested in annuities at 5% with 20% invested in higher risk investments (10% returns) and 30% invested in moderate risk investments (7% returns) etc.

    Also, the history of significant drops in the market, suggests that one does not want virtually all of ones assets exposed to the market.

    Hope this helps. Roy

    Reply
    • Nathaniel Pulsifer
      Nathaniel Pulsifer says:

      Thanks Roy- those are some great additions- I appreciate it. You really can create a safe yet protected portfolio this way, laddering your returns with reinvestment, and limiting exposure to riskier assets, that may capture growth but will also not capture huge losses due to the limited allocation.

      Thanks for the added points- I’ll put something together with the example scenario you mentioned- 50%/20%/30% and show the blended yield.

      Reply
  2. bill keenan
    bill keenan says:

    Hi Nat Just waiting for my fixed annuity contract to end in 2014 and I will be back to purchase secondary market annuities again which is better than bonds and the market for security for my family and heirs

    Bill Keenan, Maine

    Reply
  3. Dale
    Dale says:

    Hello – I am very new to all of this. I would like to start a flooring strategy, as you suggest. I am looking at an annuity with a 10 year term, with a 10% bonus that is vested in 16 years. Is this what you are talking about as it relates to income & growth, and where some percentage of your money should go to, or am I off track with the flooring concept? Thank you for your help.

    Reply
    • Nathaniel Pulsifer
      Nathaniel Pulsifer says:

      Hi Dale-
      A flooring strategy basically means putting guaranteed income in place so you always have income. This frees up remaining assets to target growth, but provides overall higher level of portfolio safety. I’m not quite clear on the annuity under consideration- it seems strange to have a bonus that vests after 16 years, on a 10 year case. Perhaps the bonus vests gradually over 16 years, and the surrender charge steps down over 10 years? Give us a call to go over contract specifics and we can help you understand if it’s appropriate for your situation.

      Reply

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