In today’s inflationary environment, uncertainty is haunting investors. People are seeing the impacts of inflation directly hurt their income. Take a salaried worker who just received a fixed 5% percent raise, usually something that would be worth celebrating. If inflation is 5% or more this year, that raise is just keeping the worker’s salary on par with inflation, not increasing their purchasing power.
Many Americans are unfortunately grappling with this weakening of their income right now. To help secure their financial future, some are turning away from riskier investments and looking for more stable options like annuities, which reached record sales levels in 2022.
But like any other investment, the principle of compound investing directly plays a role in making your money work for you. Since annuities focus on meeting investor needs and goals over the long term, as with other investments, the earlier you invest, the more accumulation potential and benefits may be provided – meaning there will be a significant reward for weathering the inflationary storm we’re experiencing today.
Making the Most of Your Money
Investing in annuities as early as possible, even when the market may not appear the most optimal, can make a big difference in the size of your retirement nest egg. For example, assume a 60-year-old has $500,000 to invest and wants to access this money on retirement at age 65. There is a multiple-year guaranteed fixed annuity offering an annual rate of 5% guaranteed for five years. The potential investor suspects that interest rates may rise in the next few years but doesn't want to wait with their desired retirement date quickly approaching. With annual crediting and the compounding of gains, this individual's account grew to $638,141 after five years. This significant growth was made possible by the money's long period in the market and the steady returns fixed annuities have to offer.
Holding Out Could Hurt You
On the other hand, trying to time investments into the market could result in significant losses to potential growth, something investors should consider during periods of uncertainty. Assume the same 60-year-old individual decides to wait to invest their money because they think interest rates will rise. Luckily for them, they were right.
After withholding $500,000 from the market for two years, there is a multiple-year guaranteed annuity offering an annual rate of 7% guaranteed for three years. With annual crediting and the compounding of gains, their account grew to $612,522 after three years at age 65.
While they received a much higher crediting rate, they missed out on the time value of money for the first two years and ended up with a smaller account value at age 65 than they would have if they purchased the annuity at age 60. These examples demonstrate that time really is money, and trying to time the market could mean losing out on valuable growth potential.
What Could be Lost?
The current volatility might cause some investors to leave their money in savings accounts to avoid market downturns. Unfortunately, this strategy isn’t inflation-proof either. People who keep their money in low-interest accounts lose purchasing power over time if the interest rate on that account is lower than the inflation rate.
Suppose the same 60-year-old individual decided to put $500,000 in a savings account with an interest rate of 0.25%; after five years, that money would be worth $506,281. However, after adjusting for an average inflation rate of 2% per year, that money would only be worth approximately $458,555 in today’s terms.
Compare this to the guaranteed fixed annuity offering at an annual rate of 5% for five years, which after adjusting for an average inflation rate of 2% per year, would be worth approximately $577,984 in today’s terms; this is $119,429 more than the nest egg provided by the savings account. Keeping cash in savings can prove to be a costly mistake, and this example serves as a reminder of how important it is to invest, even during uncertain economic times.
This article was written by Dave Hanzlike, Guest Contributor from The Street Retirement and was legally licensed through the Industry Dive Content Marketplace. Please direct all licensing questions to legal@industrydive.com.