Roger Ibbotson Weighs in on Fixed Index Annuities

Roger Ibbotson Weighs in on Fixed Index Annuities

When Roger Ibbotson recently published a new report on fixed indexed annuities and their place in an optimized retirement portfolio, everyone took notice. Few economists and financial researchers garner the attention and level of respect that he does.

He is Professor Emeritus at Yale School of Management, former chairperson of research firm Ibbotson Associates, and chairman as well as chief investment officer at Zebra Capital Management. Ibbotson is also a prolific author, having conducted financial research on many topics including investment returns, mutual funds, international markets, portfolio management, and valuation.

In past studies, his analysis has been groundbreaking and his principles adopted by financial markets at large. So, it’s not surprising why his research on fixed index annuities has gained such wide attention.

In his latest study, Fixed Indexed Annuities: Consider the Alternative, Ibbotson expands his view of the use of a fixed index annuity (FIA). Here, he defines a fixed index annuity as a tax-deferred retirement savings vehicle that “eliminates downside risk while allowing for the opportunity to participate in upside market returns.”

As baseline benefits, he believes that fixed index annuities, if properly structured, can help control financial market risk and mitigate longevity risk.

What Else can Fixed Index Annuities Offer?

“Given the current low-yield environment, bond returns for the next several years will likely be based entirely on yield. Although the lower risk may be appropriate as we age, the returns may disappoint or be insufficient to maintain necessary income in retirement,” according to his report.

In introducing the study results, he reveals this finding: “My colleagues and I will show that a generic FIA using a large cap equity index in simulation has bond-like risk but with returns tied to positive movements in equities, allowing for equity upside participation. For these reasons, an FIA may be an attractive alternative to consider.”

Index Annuities, a New Option for Retirement Portfolios?

There may be several goals for a retirement plan, but often the primary goal is to provide a steady stream of income that lasts for a retiree’s lifetime.

For many retirees, a common indexed annuity strategy is using the contract for an “income floor.” In other words, a retiree pays for fixed living expenses with the consistent, recurring fixed income stream provided by the FIA. In recent years, fixed index annuity sales have reached new heights in the United States.

Events like these have given fixed index annuities a place of consideration in retirement portfolios nationwide. But, still, financial advisors may view FIAs as an alternative to traditional asset classes, such as stocks and bonds. That is why the weight of Ibbotson’s findings helps expand the view of the potential for index annuity contracts.

“…Too often, we simply accept conventional wisdom, which prevents us from considering other alternatives,” he says in his report’s introduction. “Although it is prudent to de-risk portfolios approaching retirement, are bonds our best option? Can we potentially realize a better result?”

Breakthrough Research Spotlights the Potential

Ibbotson goes on to say: “Recent innovations in annuity product design, combined with an increasingly competitive marketplace, have given individuals preparing for or in retirement powerful and more affordable tools to not only mitigate retirement risks, but also to serve as a vehicle to increase wealth leading up to retirement.”

So, what about Ibbotson’s study outcomes? A recent ThinkAdvisor article describes the findings:

“He [Ibbotson] simulated the performance of $1 invested in an uncapped large-cap equity index FIA compared to the performance of long-term government bonds over the period from 1927 through 2016, net of expenses. He assumed annual expenses of 10 basis points for a passive stock portfolio and 10 basis points for a passive bond portfolio.”

“The hypothetical maximum annualized return for the FIA was 5.81% compared with 9.92% for large-cap stocks and 5.32% for long-term government bonds. The maximum annualized return for a three-year holding period of the FIA was 27.56% versus 30.76% for large cap stocks and 23.3% for long-term government bonds. The minimum annualized three-year return of the FIA was zero compared with a 27% loss for large-cap stocks and 2.32% loss for long-term government bonds.”

“Ibbotson also compared the performance of a 60/40 stock/bond portfolio to that of portfolios with 60% stocks, 20% bonds and 20% FIAs  and 60% stocks 40% FIAs  over the same 1927-2016 period.”

“The average return of the 60/40 stocks/FIA portfolio was 8.77% versus 8.66% for the 60/20/20 stocks/bonds/FIA portfolio and 8.55% for the 60/40 stock/bond portfolio.”

“Ibbotson also simulated the performance of those three portfolios when annualized three-year return for large-caps were flat, down 10%, up 10% and up 20%. The two portfolios incorporating FIAs outperformed the 60/40 stock/bond mix only when stocks had positive three-year annualized returns of 10% and 20%, not when stocks were flat or lower.”

“Ibbotson then overlaid interest rate increases on those four comparisons. He found that when rates rose 1%, 2% or 3% the expected three-year annualized returns of the two portfolios that included FIAs outperformed the 60/40 stock/bond portfolio. They either lost less — when equities fell — or gained more when equities rose by 10% or 20% on a three-year annualized basis.”

While these study findings are insightful, we should also keep in mind that everyone has different needs — and requires different solutions for them. It goes without saying that every portfolio should be structured to suit a client’s unique financial picture and their tolerance for risk.

A New Asset Class to Consider?

Characterizing the findings of his study, Ibbotson says, “In simulation, the FIA performed better net of assumed fees than long term government bonds. We showed the FIA had comparable volatility to bonds but with better downside protection.”

He continues: “In our study, when bonds underperformed, the FIA performed quite well. It is our view, considering today’s low interest rate environment and our modest expectations for bond returns in the coming future, FIAs are an alternative to consider.”

Less Growth, More Risk… Insights from Behavioral Finance

Over their volumes of research, Ibbotson and the team at Zebra Capital Management have noted the impact of “behavior finance” on money matters outcomes. 

Within economics, behavioral finance refers to insights from cognitive psychology that reveal how and why some people make irrational investment decisions. When Zebra applied behavioral finance to the equity markets, their team made two important findings:

  • Investors’ irrational decisions may add volatility and risk
  • The most popular stocks historically have provided lower returns

Based on its findings, Zebra combined its research methodology with a daily risk control methodology to create a proprietary, large cap, “rules-based index.” 

Ibbotson and company believe that over the last 17 years, “U.S. treasury bills have failed to keep pace with inflation, and large cap U.S. stocks have experienced significant drawdowns, reducing returns. Long-term bonds have been consistent, but today’s interest rates are near historic lows.” The proprietary index, Zebra says, could offer the potential for more stable accrual and more control of volatility.

It’s a noteworthy claim, given how Ibbotson has observed bad financial decisions affect various retirement outcomes, such as reduced money growth and elevated portfolio volatility.

Takeaway: All Options on the Table

Perhaps the most important takeaway from Ibbotson’s analysis is the need to look beyond the norm when planning for income, risk protection, and asset growth potential.

By working in tandem with their financial professional, people can evaluate their personal preferences, their unique retirement planning profiles, and their goals. Then they can consider the complete range of options to help them meet their objectives.

Need Professional Guidance?

What if you don’t have a financial professional? This is an excellent time to start looking for someone. They can help you evaluate your current financial progress, create or refine strategies for your goals, and develop a personal game-plan for your personal retirement vision. And if you already work with a financial professional, but wonder if you can do more?

It’s good to consider secondary opinions, especially as you near the retirement home-stretch. Income planning and other retirement strategies are quite different from the financial and accumulation strategies people pursue in their working-age years.

Be sure to look for financial professionals with a particular specialty of retirement, its specific nuances, and solutions to help you make the most of your golden years.

If you are on the lookout for a financial professional, many stand ready to help you at Use our “Find a Financial Professional” section to connect with someone directly. Should you need a personal referral, call us at 877.476.9723.

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