Basics are the best
For years I have been promoting the unique combination of safety combined with upside potential that equity indexed annuities offer. What I am going to pass along this month can serve and is intended as bit of refresher course on underlying stocks and stock market indices. I am not so presumptuous as to infer that I am teaching anyone anything new or startling. Rather, I’m just getting back to the basics, and in my opinion, when it comes to our hard earned money, basics always beat bravado. Just look at the mess that “sophisticated investment opportunities” created in 2008. It drastically affected the markets and our entire economy, understandably leaving many of us more than a little gun shy.
What is a stock? When people invest in the stock market, they are buying shares of common stock representing proportional ownership of the underlying company. Stocks are also referred to shares or equities. Key point: When you own a stock, you own a slice of the company.
What do you get? The investor primarily gets the opportunity to earn (or lose) money based on the share value at the time they choose to sell the stock. You can attend the company’s annual meeting in person or by proxy and have the right to vote. In most cases, investors buy shares in hopes of making money if they can time selling the shares at a time when the stock has higher value than their initial purchase price.
What are indexes like the S&P 500 or the Dow Jones Industrial Average? There are more than 5,000 listed companies in the U.S., and not all are actively traded. Baskets of actively traded companies are assembled and tracked as a group called an index. The Dow Jones Industrial Average has 30 companies. The Standard & Poor’s 500 has, predictably, 500. Following an index is much easier than following every listed company. Key point: Performance is tracked by measuring a chosen basket of stocks.
What are options: A stock option is a contract which conveys to its holder the right, but not the obligation, to buy or sell shares of the underlying security at a specified price on or before a given date. After this given date, the option ceases to exist. Key point: This gives an individual or an institution the opportunity to choose whether to exercise the option depending on the profitability of the transaction.
What does this all mean in the context of this discussion? Basically, it allows an institution, in this case the insurance company issuing equity indexed annuities to take a very small portion of invested assets to purchase options with the remainder placed in highly rated bonds. Through options, they can take advantage of index gains when available. And, even more importantly, their clients are fully protected from any potential losses when the indexes are down.
Interestingly enough, some innovative companies have even implemented this concept into life insurance, which I will be discussing in all forms and extensive detail over the next few months.
Dennis Foster has been helping families with financial and estate planning needs for over 20 years. He welcomes comments and questions and can be reached at 605-887-7069 or firstname.lastname@example.org.