When it’s stormy outside, we humans naturally seek a cozy cave to hide out in for protection. That’s what we do with our money, too. Bonds have been a traditional “cave” for retirees’ “safe money”—especially for those who believe they only have three choices when allocating their nest egg: cash, stocks or bonds.
But how safe is that cave? Could rocks start falling from the ceiling? Financial analysts warning of a bond bubble on the verge of bursting think so.
Type “bond bubble” into your web browser and you’ll get over 44,400,000 hits on the subject, from such sources as Forbes and MSNBC.
The reason it’s such a hot topic is the assumption that people flee to bonds for safety purposes. But, of course, bonds are interest-rate sensitive and interest rates are about as low as they can really go. Assuming interest rates rise, that “safety play” has now, potentially, cost that client money. There is no upside potential from bonds if interest rates are going up. But, your equity position is going down because of the unstable environment. Essentially you are cutting off your nose to spite your face.
Indexed annuities are an alternative to bonds that not enough people know about. Our job is to educate people about them at every opportunity. Because, even though annuity pricing is affected by the bond climate, annuity guarantees remain a huge advantage.
Aren’t Insurance Companies Bond Investors?
“Would a bond bubble affect an insurance company that invests in bonds to back its annuities?” Absolutely, large insurance companies are affected by bond interest rates. But their advantage can be summed up in two words: buying power. And for that matter, two more words: staying power.
Because of their enormous buying power, they purchase bonds at institutional pricing, which allows them to pay lower prices for bonds than the price an investor pays through a broker. Those deep discounts allow them to still reward annuity customers with benefits.
Clearly, we need to educate clients on the safety and guarantees, not rate of return. The most successful advisors do a little of both. In order to continue to be successful in today’s environment, we need to focus our conversations with retirees on safety and guarantees. We’ll get back to rate of return when the insurance companies benefit from rising interest rates.
Until then, remember that the need for safety is as old as that first caveman searching for shelter from the storm. It’s a powerful motivator…especially when utilizing a fixed indexed annuity as an alternative to individual issue bonds, bond funds and as part of an asset allocation mix.