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Annuities vs Mutual Funds


Annuities and mutual funds are two entirely different investments, with entirely different purposes, but both can be used to build a solid financial footing throughout retirement.

The only fair comparison between annuities and mutual funds (especially stock mutual funds) is in comparing periodic-payment annuities and standard stock mutual funds.

Periodic-payment annuities are those that allow you to invest in chunks. Very much like a standard stock mutual fund that allows you to invest as little as $25 monthly, you can invest whatever sum you’d like into a periodic-payment deferred annuity to build up capital until you decide to receive monthly payments. As you can see, annuities and mutual funds are very much similar here.

Where the two investment types diverge is in their performance, and how their performance works. For this example, we’ll use an S&P 500 index mutual fund and a deferred annuity based on the S&P 500. You would think that the performance of the mutual fund and the deferred annuity would be similar, since they track the same investments, but you’d be dead wrong.

Your annuity cannot lose money.

What? Wait! I thought all investments were risky.

Nope, not all investments are created equally. The S&P 500 mutual fund tracks the performance of the S&P 500 index up and down, whereas the annuity based on the S&P 500 index only tracks the index when it moves up.

The deferred variable annuity based on the S&P 500 rises in value with the S&P500 but only to a certain degree. You see, your annuity broker will promise to protect you from stock market drops, but they also limit your upside. For example, if the S&P500 index were to rise 15% in one year, your S&P500 mutual fund would appreciate by 15% where your annuity may rise the maximum cap of 7-10%. However, if the S&P500 were to plunge 20%, your annuity would lose nothing and your mutual fund would lose the full 20%. When the stock market is performing well, the mutual fund will outperform the annuity, but in bear markets your annuity will perform better.

Finding common ground

Investing in stock mutual funds at 65 is like betting on horses to secure your retirement. Likewise, investing all your money in an annuity at 20 is equivalent to stocking all your cash under a mattress for extreme safety. Both can be used in conjunction with one another, and effectively as well.

Conventional wisdom is to take 100, subtract your age from it, and that is the amount you should have invested in stocks, the other part should be in fixed income. A 30-year old, for example, should invest his or her money 30% in fixed income (like an annuity) and 70% in stocks. At 40, that same person would invest 10% more in fixed income and 10% less in stocks. Simple, right?

A proper balance of annuities and stock mutual funds will allow for solid capital appreciation as well as safety in turbulent markets. It isn’t about one or the other, its all about a proper blend of both at just the right time.