Key Takeaways
- Variable annuities facilitate market participation but discourage frequent asset buying and selling, helping variable annuity owners avoid reactionary decisions that can result in long-run losses.
- Because variable annuities are intended to be long-term investments in retirement income, they can help investors resist the urge to try to time the market.
- The living benefits of most variable annuities may allow owners to invest more aggressively without fear of risk, resulting in higher return potential.
Investing requires making tough decisions, and many investors need help avoiding costly mistakes.
Some of the most common investing mistakes, according to the CFA Institute, include:
- Letting emotions get in the way
- Trying to time the market
- Not having clear investment goals
Variable annuities may address many of these common mistakes. When you purchase a variable annuity, your premium is allocated to investment options you can choose. The value of your annuity depends on the performance of your investment portfolio.
By acting as an intermediary between the investor and the market, variable annuities allow investors to allocate their portfolio more aggressively and maintain their allocations for longer, which some studies show may enable them to capture more gains than those who invest directly in the market.
Let’s examine some examples of how variable annuity owners can sidestep some of the most common investment mistakes.
Letting Emotions Get In the Way
The influence of emotions on making sound investment decisions cannot be overstated. According to the CFA Institute, “Investing brings up significant emotional issues that can impede decision making.”
Anxiety over market conditions can lead to less favorable outcomes when investors make decisions based on fear over rationality. During periods of economic uncertainty, we may spend more time consuming news that tells us how poorly the market is performing because anxiety increases the brain’s appetite for negative information.
When this happens, our reactive instincts can override rational thinking. During a market drop, investors are likely to move more of their portfolio into cash investments, which are considered safer.
However, in the long run, this can hurt your growth potential. By moving your portfolio into safer assets during a downturn, you miss out on gains when the market recovers. Ultimately, you may have come out with even more growth had you stayed the course when the market dropped.
This is where variable annuities come into play. Although variable annuity owners can reallocate the investments in their portfolio, they are more likely to stay the course. Investing in a variable annuity may put someone into a more long-term mindset, as these products gear towards supplying retirement income.
From that perspective, it’s easier to hold steady during market downturns, knowing that your portfolio will have time to recover before you start taking income from your annuity.
Another factor that allows variable annuity investors to feel more confident is the inclusion of living benefits. Over 80% of variable annuities are sold with one of these riders, which typically guarantee accumulation, growth or income during the annuitant’s life.
Living benefits allow variable annuity owners to invest more aggressively than they otherwise would because they know the living benefit provides downside protection. This assurance gives owners the peace of mind to make more informed and forward-thinking investment decisions.
Is An Annuity Right For You?
Trying To Time the Market
Another common mistake happens when investors think they can time the market. “Buy low, sell high,” is the mantra many investors live by, but how do you know you’re buying investments at the lowest possible price or selling at the highest price?
The mutual fund polling group Dalbar conducts a yearly Quantitative Analysis of Investor Behavior, in which the performance of the S&P 500 is compared with the average return of an equity fund investor.
Dalbar’s research repeatedly shows that investors are not as good at timing the market as they believe. In the 2024 report, Dalbar found that the average equity fund investor only captured 79% of the S&P 500’s gains over the last 30 years.
As previously mentioned, those who invest directly in mutual funds move in and out of their investments faster than variable annuity investors. As a result, mutual fund investors might miss out on gains because they make a move in the wrong direction, selling a fund right before it gains value or buying a fund that then loses value.
By contrast, variable annuity investors alter their investment allocations less frequently. By not guessing which way the market will go in the short term, investors can focus on performance over a longer time frame and potentially capture more gains.
Not Having Clear Investment Goals
Variable annuities can also help investors avoid the common mistake of not having clear investment goals. According to the CFA Institute, an investor’s strategies and portfolio design should always focus on long-term investment objectives. However, it’s prevalent for investors to get sidetracked by fad investments or short-term returns.
Variable annuities address this problem in a few ways. First, the products serve specific purposes; they grow tax-deferred and can provide guaranteed income in retirement. These objectives position variable annuities as a viable investment for investors who have maxed out their 401(k) and IRA and want to contribute additional income towards a tax-advantaged retirement savings plan.
Second, the owner can customize variable annuities to fit their unique needs and goals. Like a brokerage account, you can tailor your investment portfolio’s allocation to your risk tolerance level.
The ability to add on a living benefit sets variable annuities apart by letting owners further customize their contracts based on their priorities.
Suppose your primary concern is establishing an income stream in retirement. In that case, you can purchase a guaranteed minimum income benefit (GMIB) that assures you’ll receive at least a minimum amount of income no matter how your underlying assets perform.
If capturing gains matters the most to you, a guaranteed minimum accumulation benefit (GMAB) can ensure that your initial investment will accumulate a minimum growth by the end of a specified period.
By customizing the contract with investment allocations and living benefits, variable annuity owners can create an investment strategy and portfolio that will likely achieve their long-term goals.
Guarantee financial freedom with an annuity.