Recent articles in the financial industry press have suggested that annuities should be considered as an asset class for investors seeking to reach an optimal allocation for their investment portfolios. It comes as no surprise that for the most part these articles are written by and for insurance companies which are the creators and sellers of annuities. (In the interests of full disclosure of potential conflicts with their customers, it is useful to know who is touting these products and why).
First, it is important to understand that an annuity is a contract with an insurance company and the insurance company takes the investor’s money and invests it in equities and bonds and other traditional asset classes so as to be able to pay for its promises to the investor, along with expenses. Unlike many asset classes, the annuity as a single product entity is not something the investor can buy and sell at will or adjust freely when the mood strikes. Surrender charges and the built-in fees and restrictions in an annuity keep it from being very liquid.
Do these factors mean the annuity is really not an asset class? The answer is these factors are not inconsistent with the annuity being looked at as an asset class since there are other asset classes which are equally or even more illiquid and are based on contracts or are subject to restrictions and limitations on sale or exchange. That said, it is important to understand the nature of the annuity if you are considering making one a part of your investment portfolio exactly because it does not perform like the traditional asset classes we know. For example, the more traditional asset classes have much history and analysis that can be helpful in making investment decisions. Annuities don’t have the same benefit and are very dependent on the insurance company’s choices and requirements, which are constantly changing and driven by the insurance company’s interests first. The investor, in effect, is adding a layer of uncertainty to the investment portfolio because instead of choosing the investments (with or without an adviser) the investor is choosing the annuity and having the insurance company make the selection of the underlying investments.
Other considerations with that annuity decision should be the nature of the guarantees offered by the insurance company (and their cost) and how dependable that insurance company is and is hoped to be. The annuity can hold an important place in your portfolio but only if you do your homework and fully understand what it is and how it will work for you.