The 3 Different Ways to Invest Your Money: Part 5: Indexed Accounts

This is the fifth and final part in my series on ways to invest your money, click here to read part one, part two, part three, or part four.

As I mentioned in my last post, when discussing Index Accounts, there are two philosophies at play.

#1 – The average investor/money manager can’t beat the performance of the stock market.

#2 –Never lose your money.

I’ve already discussed the first philosophy, and in this post I’ll be discussing the second philosophy.

                                                                                                                                                 

When discussing Index Accounts, it is important to mention that having your money in Index Accounts can mean several things.  For instance, some Index Accounts fall into the category of Variable Accounts, in that your investment can go up and down, depending on how the particular index performs.

Other types of Index Accounts are designed to protect a person’s principal, and previously earned gains, without the risk of losing money when the market goes down.  These are the type of index accounts that I’m referring to in this post.

                                                                                                                                                 

I believe it was billionaire investor Warren Buffett who said, Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.” 

This is the basic theory behind investing your money in Index Accounts that protect your principal, and previously earned gains, without the risk of losing your money when the market goes down.

Like all investments, these types of accounts are very complex and detailed, and would be impossible to fully explain in a short article.  However, the basic underlining principals are fairly straight forward.

These types of investments are offered through insurance companies – which is why your principal investment and all future earnings are protected – and it does not have to be in a life insurance policy.  The basic idea is that, as long as you follow the contract, you will not lose any money in your account.  The “catch” – because there is always a catch to every investment – is that when the index goes up, you will typically get a percentage of the overall return.  In some years you may get 100% of the gain, and in other years you may get 50%.  Studies have shown, that over a long period of time, investors receive about 70% of what they would have received in the years the market went up.  The nice part about these accounts is that when the market goes down, there is no loss of previously earned gains.

                                                                                                                                                         

To illustrate how a potential index account may work, I created the following illustration below.

Please Note:  The last two columns show the value of your money when looking at the dates illustrated.  The second to last column, shows the value of your money if you had invested it in the stock market – specifically in the Dow Jones Industrial Average (Dow Jones for short).  *The last column illustrates the value of your money if you had placed your money in an Index Account that I’ve been referring to.  *Further notice, that when the stock market (ie. the Dow Jones) goes down, the Index Account remains unchanged.  Also, to keep the Index Account realistic, I placed a 6% Cap on the Account – many accounts are set up in a similar way.  What this means is that you will get 100% of the gain in the Index up to a 6% “cap.”

Date Dow Jones Return  $ in Stock Market (DJ) $ in Index*
7/2/01 10,522.81 $100,000 $100,000
7/1/02 8,736.59 -16.97% $83,030 $100,000
7/1/03 9,233.80 5.69% $87,754 $105,690
7/1/04 10,139.71 9.81% $96,363 $112,031
7/1/05 10,640.91 3.17% $99,418 $115,583
7/3/06 11,185.68 5.12% $104,508 $121,501
7/2/07 13,211.99 18.12% $123,445 $128,791
7/1/08 11,378.02 -13.88% $106,311 $128,791
7/1/09 9,171.61 -19.39% $85,697 $128,791
7/1/10 10,465.94 14.11% $97,789 $136,518
7/1/11 12,582.77 20.23% $117,582 $144,709
AVERAGE/TOTAL 2.6% average $117,582 $144,709*

 

*In the above illustration, the person who had their money in the Index Account, had $27,127 MORE at the end of ten years, then the person who was completely invested in the stock market.

I know that this can all be confusing, so please if you have any questions, feel free to call me for further explanation.

*The articles on this blog are for education and entertainment purposes only and should not be taken as financial advice. I understand that every person’s situation is unique and should be treated as such. Please contact me, or another financial professional, for specific advice regarding your situation. I try my best to keep the information current, but things are always changing, so it may be different now than when it was first published. If you would like more information about how something listed in any of my posts specifically affects you, please feel free to comment below, email me, or call me anytime.