Fixed income: an important part of many portfolios

June 22, 2022

In the past, I’ve spoken about portfolios and how they should be built.   There are a lot of factors that come into play when putting an investment portfolio together for a client, but at its simplest form most portfolios look something like a playground teeter-totter.  Aggressive investors sit way over on an unbalanced end of risk, while extremely conservative investors sit way over on an unbalanced end of safety.

Considering the above, all but the riskiest of portfolios contain some element of safety.  Many portfolio teeter-totters lean to one side or the other, but are balanced to a certain degree.  Generally, investors put a portion of their money on each side to make that balance right for their situation.  A 70/30 portfolio has 30% invested for safety and 70% exposed to more risk.  A large issue that I’ve witnessed is that many of us focus so hard on the 70% at risk that we don’t visit the safer side and discuss what can be made of that.

Traditionally, the safer end of that portfolio was built out of bonds.  Bonds, however do have their shortcomings.  They are mostly longer in duration, lasting 5-15 years or more.  They also typically have a coupon rate that doesn’t change, meaning that market interest rates can move up, but the bond doesn’t pay more interest.  Last, their price can fluctuate.  When interest rates move up, prices of bonds fall, which can actually cause investors to lose value in the part of their portfolio they were trying to shield from loss. 

There is a viable alternative to bonds that can help many investors avoid some of its pitfalls; an annuity.  While they’re not a perfect investment either, they have some clear advantages in today’s market. Fixed annuities offer guaranteed principal, meaning no loss of value (there is a penalty for early surrender though).  They offer interest rates that at this moment are very competitive with bonds, with even the shorter 3-year contracts paying over 3%.  They can have shorter terms than bonds, usually between 3 and 7 years.  They also have a death benefit, meaning that if the annuitant dies during the contract, the surrender fees are waived and proceeds go direct to a beneficiary. 

There has to be a catch, right?  If annuities were better than bonds, why not just use them for everyone?  Yes there are some aspects that must be considered.  Annuity owners need to be 59 ½ or older to avoid tax penalties on earnings withdrawn.  Also, they’re not liquid.  Annuities can’t be sold on the open market.  These contracts must be seen through. 

Fixed annuities have some characteristics that must be understood before using them as an investment.  For the right person, they’re a fantastic way to earn guaranteed fixed interest along with guaranteed safe principal.  Pay attention to your entire portfolio and make it work for you.

Fixed annuities are long-term investment vehicles designed for retirement purposes. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.  All performance referenced is historical and is no guarantee of future results.  All indices are unmanaged and may not be invested into directly.

Bonds are subject to market and interest rate risk if sold prior to maturity.  Bond values will decline as interest rates rise and bonds are subject to availability and change in price.