A safe money place is one where it is very, very unlikely that you will lose interest and credited gains – CDs and fixed annuities would be examples. A risk money place is one where you could lose principal and gains – a growth mutual fund is a risk money place. Both risk and safe money places should give you potential returns commensurate with your risk, and that is extremely important when considering opportunities.
- Not Worth The Risk
Say the potential return on that annuity is 5%. If a mutual fund investing in corporate bonds had a realistic potential return of 5.5% this would probably not be adequate compensation for the risk of owning the bond fund – bonds funds are risk money places because one can lose principal and previous gains.
- Too Good To Be True
But just as important, if you were offered what was said to be a safe money place with a long-term return of 11% something is wrong, because a true safe money place would not need to offer a potential return of 11% when another safe place is paying 5%.
Fixed rate annuity returns, as with CD returns, are primarily determined by what the institution earns. Rates at one place may be higher than another due to lower expenses or more aggressive earnings management, but the rates should not be too much above the competition.
Although index annuities are a safe money place that have delivered periods of double digit interest rates this doesn’t mean they are an exception to the rule. In the short run index annuities may enjoy returns associated with risk places, but pricing constraints and stock market cycles should produce long-term rates that are closer to fixed rate annuities than risk place returns. One should not expect a safe money place to perform as well as a risk place over time.
How do you determine if a safe money return is for real? If it looks too good ask specifically how the return is being produced and see if it makes sense to you. Certain safe money places offer a real potential for higher yields than others, and these higher potential places include both fixed rate and index annuities.