For decades, the traditional balanced portfolio has relied on stocks for growth and bonds for stability. The classic stock-and-bond allocation became the foundation of retirement investing because it offered investors a practical way to pursue long-term returns while managing risk.
But investing has evolved and today, we have access to solutions that didn't exist when the traditional portfolio was developed.
One product receiving increased attention is the registered index-linked annuity (RILA), prompting an important question: Should investors rethink whether traditional bond allocations are the only way to help manage portfolio risk?
The key is downside protection
Unlike bonds, which are influenced by interest rates and credit markets, a RILA may provide returns linked to the performance of a market index, such as the S&P 500, while providing a defined level of downside protection over a specified outcome period.
Many contracts today offer downside protection against the first 10% to 30% (or even 100% in some cases) of market losses over a six-year term while allowing investors to participate in the market's gains, subject to participation rates, upside caps or other contract provisions.
Protection features are subject to contract terms and limitations, and investors can still experience losses.
Portfolio construction should evolve as investment solutions evolve. For years, investors had two primary choices for long-term assets: Stocks for growth potential and bonds for stability.
Additional tools
Today, investors have additional tools that may deserve consideration depending on their objectives.
That shift has led many advisers to think less about replacing one investment with another and more about expanding the conversation. Whether a RILA, bond allocation or other strategy is appropriate depends on an investor's objectives, risk tolerance, liquidity needs, time horizon and tax circumstances.
Rather than viewing a portfolio as consisting of only two buckets (growth potential and stability), some advisers now view buffered investment strategies as a potential third category, positioned between traditional equities and fixed income.
Worth evaluating
For investors seeking growth potential with a predetermined level of downside protection, that middle ground could offer an alternative worth evaluating.
The goal isn't to declare that one investment is universally better than another. It's to ask whether the traditional portfolio deserves a fresh look.
Investors today have more choices than previous generations, and sometimes the best solution is one that didn't exist when conventional wisdom was established.
RILAs are not appropriate for everyone.
- Investors generally forgo dividends
- Upside returns may be limited by participation rates or caps
- Downside protection applies only according to the contract's terms only if the contract is held through the applicable outcome period
Most contracts also include surrender charges during the early years, and withdrawals from nonqualified contracts are generally taxed as ordinary income to the extent of earnings.
In addition, distributions taken before age 59½ may be subject to a 10% federal tax penalty unless an exception applies.
Bonds continue to play an important role for many investors by providing income, liquidity and diversification. The point is not that bonds have become obsolete. Rather, it is that today's investors have more choices for managing risk than they did a generation ago.
Perhaps the conversation is no longer simply about stocks vs bonds. Maybe it's time to consider whether modern portfolio construction includes a third bucket —one designed to bridge the gap between growth potential and downside protection. For many investors, that conversation may be long overdue.
Related Content
- Have a Negative Perception of Annuities? Consider RILAs and FIAs
- For Your Fixed-Income Pot, Consider an Annuity That Behaves Much Like a Bank CD
- I (Used to) Hate Annuities: Then I Looked at the Math
- The Truth About Annuities: The Question Isn't 'Are They Good or Bad?' It's 'Are They Appropriate for You?'
- Too Scared to Dive Into a Fixed-Rate Annuity? Interest Rates Make It Worth Dipping Your Toe In
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
