For a secure future, it's essential that you make sound investments right now. There are multiple investment options to choose from, varying in the degree of risk involved and returns promised. Two of the popular investment options that you might want to consider are indexed annuities and mutual funds. The performance of both these investment options is dependent on the performance of market listed securities, but the similarities end there. In this WealthHow article, through an indexed annuities vs. mutual funds comparison, the differences in the working of both investment vehicles is clarified for beginner investors.
What are Indexed Annuities?
Annuities are insurance products that provide the insured with a lifelong source of regular income. There are various types of annuities, which primarily include fixed, variable and indexed annuities. All of these annuity contracts can be bought through a one time lump sum payment or a payment divided over installments. After you have bought an annuity, there is a lock in period, when the investment is allowed to grow and after a specified date, the company starts making periodic payments.
All annuity investments are tax deferred until you start withdrawing money and there is no limit on how much you invest in them. An indexed annuity has its rate of return tied to a stock market index like the S&P 500. While a minimum interest rate of return is guaranteed, how much more you may earn is directly dependent on the performance of the stock market index.
Returns are limited by the maximum cap imposed on the interest rate of return and management fees paid to the insurance company. The best thing about an indexed annuity is that it's protected by the 'State Guarantee Fund', which ensures safety of principal. Annuities come with death benefit, which lets your dependents inherit the returns in case of untimely demise of the annuitant.
What are Mutual Funds?
A mutual fund uses the combined pool of investor money to buy market securities like stocks and bonds, besides investing in money market instruments like certificates of deposit. Investors receive dividends and profits made by the mutual funds, based on the performance of the securities that the fund invests in.
These funds are professionally managed by experienced stock market brokers and they provide a diversified investment portfolio. The money invested in mutual funds is taxable and capital gains taxes along with the fees paid to fund managers and brokers eat into the profit. You can liquidate your mutual fund shares at any time by selling them through brokers. Most mutual funds offer no guarantee of minimum return.
Differences Between Indexed Annuities and Mutual Funds
The prime difference between the two investment vehicles lies in the fact that annuities provide a guaranteed source of lifelong income, while mutual funds don't. While your principal is guaranteed in case of an annuity, it isn't guaranteed in case of a mutual fund. Also, money invested in annuities grows tax free until withdrawal, but money invested in mutual funds doesn't.
While mutual fund returns are dependent on the performance of a diversified portfolio of investments, the fate of an indexed annuity is decided by the performance of a stock index. The most important difference between the two investment vehicles is that annuities are insurance products, while mutual funds aren't!
By now, you must have realized that both indexed annuities and mutual funds are poles apart as investment options and differ substantially in terms of risk involved. Annuities are safer investment options with limited but guaranteed returns, while mutual funds are investments with a higher return potential but with no guarantee and high risk.