Sometimes less can be more.
Just take what happened to annuity rates during this year’s bear and bond markets. Although the dollar value of your stocks and bonds has dropped significantly, each of those dollars is now able to buy a larger annuity payout.
Indeed, depending on the specifics of your situation, these two effects will largely offset each other. The net effect is that, despite this year’s bear market, you are as well off as you were at the top of the market at the start of this year.
These countervailing forces should help us all be more optimistic about market fluctuations. It’s a bad wind that doesn’t blow good.
The accompanying graph illustrates how closely correlated annuity payout rates are to investment grade corporate bond interest rates. When those rates were at their lowest in decades a few years ago, a single 65-year-old man willing to pay a premium of $100,000 could have gotten an annuity of around $450 a month. Today, with significantly higher interest rates, that same $100,000 premium could buy an annuity payment of about $570 per month, or about 27% more.
(These figures come from AnnuitiesImmédiates.com for a “Life & 10 years certain” annuity. Such an annuity provides a guaranteed lifetime income to the annuitant, but if the annuitant dies during the first 10 years, payments continue to the annuitant’s heirs for the remainder of those 10 years. Also note that the payout rates in the table are based on averages from different insurance companies, so depending on which company you choose, your rate may be better or worse. Additionally, your payout rate also depends on the state you live in. Although annuity payout rates for women are different from men’s, I would come to the same conclusion if I focused on their payout rates instead.)
Kicking each other for nothing
Imagine you are a 65-year-old man and at the peak of the bull market in early January, you owned $100,000 of an S&P 500 SPX index,
fund and, rather than buying an annuity with that amount, you chose to bet that the bull market would continue. Your index fund is now worth about $77,400 and you blame yourself for not buying that annuity in early January.
But you don’t care. If you had entered the high of the bull market, your monthly annuity payment would have been approximately $450. With your current $77,400, on the other hand, you could get a monthly payment of around $441 per month, only about 2% lower than at the top of the bull market.
A broadly similar conclusion would be reached if you had a portfolio that was 60% stocks and 40% bonds. Even if the stock and bond holdings in your portfolio are in bear markets, I calculate that instead of the $450 monthly payment you might have gotten at the start of the year, the reduced value of your portfolio could buy a monthly payment of $456 today…about 1% more. (This calculation assumes that the bond portion of your portfolio is invested in an index fund such as the iShares Core US Aggregate Bond ETF AGG,
)
Things don’t always go so well
It’s worth pointing out that things don’t always work out so well. The most common pattern is that interest rates fall during many bear markets, for example, which is why bonds often provide a cushion against stock losses during bear markets. But note that when this happens, the annuity payout you can buy decreases with the value of your stock holdings.
There is a lot of irony here. Many investors lament that this year is an exception to this normal pattern. Rather than bonds cushioning the equity bear market, this year they suffered their own bear market. And while that’s undeniably upsetting, it does have the upside of increasing the annuity payout you can buy for the same premium.
Be careful what you wish for.
Mark Hulbert is a regular MarketWatch contributor. His Hulbert Ratings tracks investment newsletters that pay a fixed fee to be audited. He can be contacted at [email protected].
