5 Factors of Variable Annuity Investment Options

Variable annuities can play a unique role in diversified retirement strategies that help support clients’ retirement goals and keep them on track in the face of the market’s ups and downs. Like other annuities, variable annuities can provide guaranteed lifetime income when clients elect to pay for an optional living benefit rider. But a portion of the client’s purchase payment in variable annuities can also be allocated to a range of investment options that provide long-term growth potential to help maximize future retirement income.

Choosing a mix of investments that matches each client’s needs and risk tolerance allows advisors to create diversified portfolios within a variable annuity offering growth potential that aligns with the client’s retirement goals. Then the annuity’s income guarantees add a measure of income protection against market downturns. This optional rider can help clients weather market volatility with greater confidence, which may help them stay invested to reap the potential benefits of long-term growth.

Because a variable annuity’s investment options are the underlying drivers of its potential performance, it’s critical for advisors to select a product that’s flexible enough to meet a range of client needs and investment strategies. Here are 5 important factors to consider when comparing the investment options within a variable annuitiy.

Asset classes can behave differently under different market conditions, and their returns can vary widely from year to year. Because no one can predict future performance, a variable annuity that offers exposure to a broad range of asset classes can help diversify portfolios and reduce potential risk. For example, equities generally provide positive returns when held for longer periods, such as 20 years, but stock prices can also drop sharply when the markets sell off. During those times, fixed-income investments within a variable annuity’s subaccounts can act as a “shock absorber” to the annuity’s invested assets by providing positive returns.

The ability to include alternative asset classes can further diversify portfolios and supplement the return stream from traditional equities and fixed income. For example, real estate and commodities have historically performed well in inflation-driven markets and can help protect a portfolio from inflation risk.

Each asset class contains multiple sub-asset classes of investments that offer different risk and return characteristics. Advisors looking for increased flexibility from a variable annuity can consider the range of category options available in each asset class.

Within equities, for example, having investment choices across the market-cap spectrum — such as large-cap, mid-cap, and small-cap stocks — can provide exposure to different types and sizes of companies. Likewise, equity portfolios can be diversified among the investment styles of growth and value, which perform differently depending on market conditions.

A range of investment options in the fixed-income universe also can enhance diversification potential. U.S. Treasuries offer relatively low risk and low correlation with equities, helping them act as a portfolio buffer during stock market downturns. Including some exposure to additional sub-asset classes — such as investment-grade corporate bonds and mortgage-backed securities — as well as different levels of credit quality can complement other fixed-income and equity investments, because their performance does not necessarily move in lockstep with investment-grade bonds.

American investors tend to favor domestic stocks and bonds — failing to take full advantage of diversification benefits of non-U.S. investments. For example, while U.S. stocks represent roughly half of overall global market share, investors tend to invest about 70% of their assets in the U.S. equities.¹

A variable annuity with global investment options can help provide international exposure for clients. That exposure might include investments in developed countries — such as Germany, France, and Japan — as well as in emerging markets such as Brazil, China, and India. Emerging-market investments can be riskier, but they can offer higher potential returns and performance that is less correlated with developed international markets and the U.S. market.

Much of the mutual fund landscape is divided between two investing approaches: actively managed funds versus passively managed funds. Each approach has different features and benefits. Active managers attempt to outperform indices and may charge higher fees for that service. Passive managers seek to track indices and may appeal to clients focused on minimizing fees.¹

Advisors who want to appeal to clients’ preferences might seek a variable annuity that offers both passive and active investment options.

In addition to offering choices from a menu of individual investment options, some variable annuities offer turnkey portfolio solutions, such as asset-allocation portfolios designed to accommodate a range of investor risk profiles. Other options include risk-managed portfolios that use different strategies to provide a measure of downside protection.¹

Choosing a variable annuity that offers both customizable investment options as well as turnkey portfolio solutions can give advisors more flexibility in developing investment strategies based on their preferences and meet clients’ personalized goals.

These five factors are an important starting point when examining a variable annuity’s investment options.

For example, advisors can closely examine the investment options within a variable annuity’s asset classes and investment categories. They should also consider each client’s unique needs, including their risk profile and goals for retirement, to assemble the appropriate diversification strategy.

In addition, advisors can examine how adding a variable annuity with a guaranteed income rider might provide greater flexibility in a client’s retirement plan — such as diversification decisions relative to other investment and retirement planning accounts. A well diversified portfolio that provides additional sources of guaranteed income can create a more flexible income strategy, allowing clients to choose a lower annual withdrawal rate from retirement accounts. This lower annual withdrawal rate can help savings in those accounts last longer.

Greater Flexibility in a Retirement Income Plan

Adding $15,000 in guaranteed annual income from an annuity creates an additional source of funds that allows Client 2 to withdraw less from other investments and still maintain a desired $60,000 annual income target. Without an annuity’s guaranteed income stream, Client 1 may be subject to greater market volatility, requiring a higher withdrawal rate from investments to maintain $60,000 in annual income.

This diligent approach to examining variable annuity investment options can help ensure that the product they select supports an advisor’s critical role — helping clients create and stick with a financial plan that can generate future income for retirement.