InsuranceNewsNet Magazine February 2012 : 36
PurchaSing PrinciPle Annuity strategy deflects inflation better than S&P 500 By JacoB Stern ost producers who offer indexed annuities under-stand the many benefits of the product: annual reset, protection of principal, abil-ity to participate in a vari-ety of markets and tax deferral. But one important aspect that is often over-looked is how these products can help protect our clients’ purchasing power of their dollars. Many people in retirement, or near-ing it, want to ensure they can continue their lifestyle. But many do not under-stand the effect that inflation can have on their dollars. Inflation is a silent killer of purchasing power and many simply ignore this factor. Using the U.S. Labor and Statistics website, anyone can view the official inflation numbers. There have only been a few times when inflation was below zero and is often in the 2 to 3 percent range. For example, if inflation were at 3 percent for a year, people would have to earn 3 36 InsuranceNewsNet Magazine February 2012 percent on their funds just to be able to purchase the same amount of goods as they did a year ago. To make matters worse, if the person happens to be invested in vehicles that can lose value, it magnifies the situa-tion. In this article, we will examine how inflation can destroy a person’s purchas-ing power and how market losses are magnified by inflation. When beginning a conversation with clients about how much income they need in retirement, many agents forget to factor in inflation. Inflation, like losses and gains in invest-ments, has a compounding effect that’s almost always to the downside (since deflation rarely happens, even during a recession). So, purchasing an indexed annuity can provide clients an added layer to combat inflation and protect their purchasing power. The Numbers I analyzed many years of S&P 500 data to fully understand how inflation can erode purchasing power. I started with March 2000 and baselined the S&P 500 to 1000 (actual value was 1498 , but because we are looking at the percent changes, using a baseline of 1000 makes it easier to understand). In the analysis, I also assumed purchasing an indexed annuity with a modest cap of 5 percent (annual point-to-point) at the same time in March 2000. Fast forward five years to March 2005, and the baseline S&P 500 was at 851 . However, factoring in inflation, the “purchasing power” S&P 500 was at 751 . This means that if clients were 100 percent invested in an S&P 500 fund, they lost approximately 25 percent of their purchasing power. If the person looked at their annual statement from their broker, they would only observe a 15 percent loss (1000 down to 851). But because inflation has a compounding effect, the purchasing power was fur-ther depleted. In March 2005, the S&P 500 value of
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