Harness The Power Of Three In Your Practice

October 14, 2011

By John Rafferty
AnnuityNews.com

For eons, references have been made to the power of the number three. You’ve heard about “the power of three” or that the “third time’s a charm.” Well-polished politicians and savvy speechmakers have relied upon the rhetorical “rule of three,” since research shows that most people can mentally process just three key points simultaneously. Even In some of the most famous children’s stories, the power of three is reinforced: Three Little Pigs, Three Blind Mice, Three Musketeers. Three, it seems, implies a perfect balance.

Your financial practice can benefit from the power of three, too. Clients can find planning for their golden years overwhelming due to the virtually limitless array of products and a plethora of asset classes from which to choose. One way to make the process less confusing for clients who need an easily managed, long-term wealth building approach is to involve a simple, three-tiered approach in which a bigger percentage of the assets are in principal-protected products. Truly, if this economy has revealed anything to producers, it’s that many people have become more risk averse.

For clients seeking financial stability during uncertain economic times, introducing this three-pronged approach can infuse them with more confidence for the long term.

·         Prong 1: A low-risk, low-reward product like a traditional fixed annuity, a CD or a savings account

·         Prong 2: Products such as mutual funds that have exposure to the upward and downward potential of stocks

·         Prong 3: An indexed annuity that guards principal (if held to contract maturity) and offers the potential to generate higher return than a traditional fixed annuity.

With a three-pronged approach for wealth-building — that is, retaining a healthy portion of clients’ assets in principal-protected products, producers may be able to keep their clients looking toward the long term rather than the short term. As a result, this approach may lower clients’ risk of upsetting their nest eggs in uncertain market environments, where fear may drive them to dismantle their balanced portfolios and move an inappropriately large portion into one end of the risk/reward spectrum, thus endangering the potential for accumulation or even principal protection.

Prong 1: Low risk, low reward

The anchor of the three-pronged approach is the most conservative portion and includes products such as traditional fixed annuities, CDs and savings accounts. Since they’re fixed, the rate of return will not only be stable, but known up front. Due to their stability and predetermined outcomes, these products sit at the lowest end of the risk/reward spectrum.

Prong 2: High risk, high reward

Part two of the approach is a stake in the stock market via ownership of equity positions in companies, utilizing products like individual stocks or mutual funds available by investing directly in the market, in mutual funds, or in mutual funds through 401(k) plans and similar vehicles. These equity products carry more risk than fixed options, but also can feature the potential for significantly greater returns, balanced by a potential loss of principal in poor markets.

But with inflation continually eroding purchasing power over the long term, a retirement portfolio should include partial exposure to the stock market and its potential to generate returns. Taking part in the stock market is best considered a long-term approach; the market fluctuates over the short term but over time, this asset class offers stronger inflation-beating potential for accumulation than others. Retaining that long-term stance will be aided, in part, by the client’s comfort level regarding the rest of his or her portfolio, and this is where prong 3 — the indexed annuity — can be helpful.

Prong 3: Indexed annuity

Diversifying an accumulation portfolio through the integration of an indexed annuity can be a productive third prong, featuring more potential for growth than traditional fixed products and without risk to principal if held to maturity. Essentially, an indexed annuity gives the client an opportunity for a moderate increase in return, without exposure to adverse market risk.

More significantly, integrating an indexed annuity to an accumulation portfolio brings the potential to “win by not losing.” Buoyed by the added confidence that the principal guarantees offer, the consumer may start to take a longer-term view of his or her whole portfolio and be more likely to accept short-term equity losses.

With so much uncertainty in the markets when it comes to their nest eggs, clients are averse to trying anything outside their comfort zones. They may seek more traditional and safer products while expressing reluctance to participate in higher risk/reward products critical for growing their portfolios. But just incorporating an indexed annuity to their portfolios may help strike a balance between too much risk and too little, creating a better balance between traditional fixed products and equity products.

The theory of investing is fairly straightforward: Buy low, sell high and you’ll be successful. In practice, though, clients often buy high and sell low, letting emotions such as fear motivate their decisions. Allocating assets among traditional fixed products, equity products, and indexed annuity products may enable your clients to more appropriately balance risk with reward and be comfortable with their portfolios. With less riding on variable outcomes, this three-pronged approach can help remove the emotion from the process, and allow consumers stay focused on the long term.