Annuities and bonds are very often compared because they generally provide near equal returns as well as inherent safety. Also, both financial products are largely part of a long term financial plan, and are most likely used at the end of the planning stage, rather than the beginning.
Where the two products diverge isn’t in their returns, nor their prices or options, but in their inner workings. Annuities are a simply a bet made with an insurance company, usually a life insurance company, that you will live a very long life…one long enough to collect more in monthly payouts than you paid for the policy. Bonds, on the other hand, are an investment in the debt of a business. When you buy a bond, you’re buying nothing more than a promise from a company to pay you back a certain amount of money plus interest.
One benefit to bonds is that you’ll get your money back even if you die, whereas uninsured annuities stop payment upon death. Another benefit is that you have some safety when buying a basket of bonds either through an exchange-traded fund or a mutual fund. Since most individual bond purchases are made in blue-chip companies, you also have a very good chance of repayment, with little risk of default. However, on the downside, defaults on bond payments do happen, and many times they happen abruptly, with little warning.
Just think for a second. During the roaring 2000’s would you have ever expected that General Electric or General Motors would ever be on the brink of bankruptcy? Did you ever think the value of their bonds would ever plummet, or in GM’s case, go to zero? Never. They were both well financed firms with great management, but eventually their expansions lead to serious financial pitfalls.
When safety matters most, many investors opt to choose annuities. By purchasing an annuity, your payout is guaranteed never to fall, and is even insured by your state government up to a certain investment total. That is, for each individual annuity policy that you may own, the government will insure it up to a set dollar figure by law. So, even if the writer of the policy were to disappear overnight, you’d be guaranteed to get your investment back. And that, of course, is one huge benefit.
On the flipside, you’re likely to pay more in annual expenses on an annuity than you would a corporate bond mutual fund. Also, for uninsured annuities (uninsured annuities are generally a far better investment than insured annuities) your payments will cease when you die. So if you were to buy an annuity on Monday and die on Wednesday, you’d have nothing. If you were to buy a bond on Monday and die on Wednesday, you’d still own the bond, at least, your heirs would.
When it comes down to it, equity indexed annuities and bond portfolios have virtually the same amount of risk as well as reward, but with annuities you have just one more layer of protection in default insurance from your state government. We’d recommend you opt for both a blue chip bond fund as well as an annuity.
Stocks and bonds generally trade in opposite directions. Stocks fall when bonds rise, and bonds rise when stocks fall. So, in knowing that, you could practically arbitrage the market by purchasing both an annuity indexed to stock performance and a bond portfolio indexed to, well, the performance of the bond market. When bonds rise, your annuity will stay put, protected from downside risk. When stocks rise, your annuity will rise in value while your bond fund will drop in value. Just some food for thought.