Differences between Indexed Annuities and Mutual Funds

In modern day investment portfolios, indexed annuities and mutual funds play the role of safe yet high yield investment vehicles although the two are rather different from one another. However, both investment vehicles make use of indexed securities although the investment method, the return, the yield as well as the risks associated with each investment vehicle make them behave wide apart. Thus, for any beginner investor, it is necessary to understand the difference between the two and the value it brings to a diverse portfolio such as the one many investors willing to have.

What is an indexed annuity?

An indexed annuity is a type of contract between a person and an insurance company. Accordingly, the insured makes a lump-sum payment or several installments to the company to purchase the indexed annuity. The annuity is then allowed to grow for a designated period during which time the insured would not receive any returns although the investment will grow based on the performance of the stock market index such as the S&P 500 for which it is linked. However, after the designated period, the insurance company would pay the insured with a lifelong periodical return, usually each month, based on the agreed terms and conditions or else would make a onetime payment, which includes the principle, and the value it gained through the performance made by the index.

What are the pros and cons of investing in indexed annuities?

One of the main features of an indexed annuity is its guaranteed return of at least the principle. At the same time, during the growth of an index annuity, it is tax deferred, and therefore the insured will only be taxed at the time of withdrawal. Furthermore, the insurance company would guarantee a minimum return based on an agreed minimum percentage while the maximum return would also be capped at a maximum interest rate. However, the amount of investment that can be made on indexed annuities is limitless, and therefore it is possible to earn more depending on the investment made and the performance of the index the annuity is being linked. As with many other investment options, indexed annuities would also carry an operational fee, which will be deducted by the insurance company. Lastly, the index annuities come with death benefits, which allow named dependents to claim the annuity benefits if the insured demise during the contract period.

What is a mutual fund?

A mutual fund is a company, which pools money from many investors and re-invest the same in a diverse portfolio, which includes stocks, bonds, short-term money market instruments and other securities or assets. Therefore, the investors investing in mutual funds would proportionately hold shares in each and every investment made by the mutual fund although the investors are distant from holding direct ownership of these instruments.

What are the pros and cons of a mutual fund?

A mutual fund on the other hand can be thought as less secure than an index annuity as there is no guarantee of at least the principle investment being returned on its maturity. However, given the diversity of its portfolio and the sole dependence on the profits made by each of the investment instruments, the mutual funds can generate a higher return than an indexed annuity, which has a maximum interest on its earnings. At the same time, an investor of a mutual fund can sell the shares back to the fund while indexed annuities would not give the investor the same flexibility. However, as with the indexed annuities, the mutual fund investors would also have to pay the fees to the company managing the mutual fund although it guarantees that the fund will be handled by experts and professionals of investment which may not be the case with indexed annuities which usually does not involve any aggressive investment strategies.