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“How can any company afford to let your money increase when a particular market goes up without making you participate in the markets losses as well?” It just seems too good to be true; but fortunately, it’s not. It’s very real and very possible.
If you’re familiar with the many different terms in the financial universe then you have likely heard of a financial tool called an “option.” However, you may not know what an option is or how it works.
An option is simply a tool that allows a person to profit from the direction of the market. If a person owns an option, he or she doesn’t own any particular underlying stock. Rather, the option owner is simply betting on (and will make a profit or loss from) the direction of a market movement.
There are two basic types of options: Puts and Calls. Those who own a Put option make a profit when a market goes down. Those who own a Call option make a profit when a market goes up. In it’s basic form, it really is that simple.
So here’s how all this works together… When a client purchases a Fixed Indexed Annuity, the vast majority of his or her annuity premium goes to purchase a solid, balanced, and diversified bond portfolio. Because this bond portfolio generally produces a return based on interest rates, it’s predictable and carries little to no stock market risk. It will produce the same rate of interest regardless of whether these markets go up or down.
However, not all of the annuity premium goes into the bond portfolio. A very small portion of the clients annuity premium also goes to purchase call options on an index that the annuity is tracking. If this particular index, such as the S&P 500 goes up, these call options create an increase in value, allowing the insurance company to credit interest based on some or all of the gains. And if the market these options are tracking goes down, the small amount of money used to purchase the option expires worthless, much like the premium you might pay for auto insurance in a year you don’t have an accident. And, even in a losing year, the cost to purchase that option by the insurance company is soon recouped by the income that is produced from the diversified bond portfolio.
Simply put, bonds provide the downside protection, and options provide the upside growth potential.
None of your money is actually invested in that particular market the Fixed Indexed Annuity is tracking…and that is why you have no actual market risk. This is critically important (and exciting) to understand. I hope this makes sense? If nothing else, just know that this strategy is not some mystical leap of faith, but rather a predictable set of calculations prepared by some of the worlds most talented mathematicians.
*Guarantees provided by annuities are subject to the financial strength of the issuing insurance company; not guaranteed by any bank or the FDIC. Guaranteed lifetime income available through annuitization or the purchase of an optional lifetime income rider, a benefit for which an annual premium is charged.
This information is designed to provide a general overview with regard to the subject matter covered and is not state specific. The authors, publisher and host are not providing legal, accounting or specific advice for your situation.
Licensed Insurance Professional. Respond and learn how insurance and annuities can positively impact your retirement. This material has been provided by a licensed insurance professional for informational and educational purposes only and is not endorsed or affiliated with the Social Security Administration or any government agency. It is not intended to provide, and should not be relied upon for, accounting, legal, tax or investment advice.