Indexing Strategies – The Key to Fixed Index Annuity Growth

Indexing Strategies – The Key to Fixed Index Annuity Growth

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Last week’s post introduced the two ways that fixed index annuities grow: (1) minimum guarantees and (2) indexing strategies. The minimum guarantee feature, which was discussed last week, is the security blanket that provides the foundation for growth of a fixed index annuity. Per the conclusion of last week’s post, this is the minimum accumulation value that would be paid by the life insurance company to the investor if the investor terminates his/her contract, or to the beneficiary in the event of death.

As discussed in the July 18, 2011 post, Looking for Upside Potential With Downside Protection – Take a Look at Indexed Annuities, indexed annuities are a hybrid product, with returns directly tied to the performance of a stated stock market index. When you complete a fixed index annuity application, you need to choose, and allocate between, one or more indexing strategies.

There are actually two choices that you need to make when selecting a particular indexing strategy: (1) Stock market index and (2) Indexing method. In addition to making these two choices when you invest in a fixed index annuity, you typically have the opportunity to change them on each contract anniversary. Stock market indexes will be discussed in this blog post with a discussion of indexing methods deferred to next week.

As defined in Retirement Income Visions™ Glossary, a stock market index measures the performance of a specific group of stocks. A common stock market index that’s typically offered as one of the choices, if not the only choice, is the Standard & Poor’s, or S&P, 500 Index. The S&P 500 is an index of 500 large cap stocks weighted by market value that’s designed to be a leading indicator of the overall U.S. stock market performance.

Other stock market index choices that may be available for fixed index annuities offering multiple choices include the Dow Jones Industrial Average, Nasdaq 100, Euro Stoxx 50, as well as a blended index. The Dow Jones Industrial Average, or DJIA, is the oldest and most popular stock market index in the United States. It’s a price weighted index that includes just 30 companies, and, as such, isn’t considered to be as good a measure of the overall stock market as the S&P 500.

The Nasdaq, or National Association of Securities Dealers Automated Quotation system, is a computerized trading system that doesn’t have a physical trading floor. The Nasdaq 100 is an index composed of the 100 largest, most actively traded U.S. companies listed on the Nasdaq stock exchange.

The Euro Stoxx 50 is a market capitalization weighted stock index of 50 of the largest European companies that have fully transitioned to the euro currency. Weightings are adjusted each quarter and the index is reconstituted on an annual basis in September.

In addition to the foregoing stock market indexes, fixed index annuities may also offer a blended index as one of the available choices. A blended index consists of a specified weighting of three or more of the most popular indexes offered. When available, it provides an opportunity to participate in multiple indexes by choosing a single index vs. making specified percentage allocations amongst multiple indexes.

Finally, while not a stock market index per se, most fixed index annuities also offer a fixed account. This option pays a specified low interest rate that isn’t tied to the performance of a stock market index.

Choosing one or more stock market indexes is the first step when selecting an indexing strategy. The second step, choosing an indexing method, which is the topic of next week’s post, is more complicated.

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