For many investors, the concept of an equity indexed annuity (EIA for short) - which establishes a guaranteed minimum rate of return, and the ability to capture the upside of the next bull market with no risk of loss - is proving irresistible. That's especially true at a time when the Standard & Poor's 500 Index [[^GSPC]] is still down nearly 45% from its 2007 high of 157.52 and new U.S. President Barack Obama's stimulus plan has yet to be finalized.

But at the risk of receiving more than a few sharp emails from industry professionals who sell EIAs, let me tell you that you can achieve virtually the same degree of financial security using nothing fancier than a certificate of deposit (CD) and the SPDR Trust (SPY), which trades on the American Stock Exchange.

Here's what you need to know.

First created on Feb. 15, 1995, equity indexed annuities are insurance products that typically promise a set minimum income level or rate of return, plus the ability to capture market gains without any risk of losing money. Theoretically, they're easy to understand.

You invest a lump sum for a fixed-time period - often 10 years or more - and in return receive a guaranteed minimum rate of return, plus the market upside, with none of the losses if it goes down.

If the market to which an EIA is indexed - like the S&P 500 - rises by more than the minimum promised return, your money is supposed to grow proportionately. In exchange for making the investment, the insurance company offering the EIA guarantees that your money will never drop in value.

The devil, as they say, is in the details.

In reality, the paperwork that explains equity-indexed annuities is one of the toughest financial documents of all to decipher and understand. Not only are the sales documents filled with legalese, but assuming you can get through the 40 to 60 pages of stuff that comes with an EIA, chances are you'll find a wide range of conditions, restrictions and terms that frequently change over time. There are guaranteed minimums, performance adjustments, participation rates, interest-rate caps and spreads to contend with, for instance. And that's just a sampling.

In addition, many EIA's also cap the returns you can achieve, no matter how far the markets rise, which would seem to defeat the purpose of investing in one of these things in the first place. And that means, more often than not, that you'll be left in the dust if the markets really take off.

To put this into context, if you invest in an EIA with a performance cap of 10% and the markets actually rise 20%, you'll leave over 50% of possible gains in the insurance company's pockets ... not yours.

Then there are the associated fees and charges, which are quite hefty. In fact, various studies suggest that the purchase of an annuity typically results in a wealth transfer of as much as 15% to 20% from the investors who buy them to the insurance companies and the sales forces who sell them. That's something not a lot of folks realize when they consider purchasing one of these specialized investments.

Despite these shortcomings, sales of EIAs are better than ever. According to Jack Marrion of Advantage Compendium Ltd. (, investors have plowed more than $123 billion into equity indexed annuities. He added that "more than 90% of EIAs are sold by independent agents," like one I spoke with who privately told me that sales are "up 25% in the last 6 months alone."

Another insurance company representative, who also wished to remain anonymous, told me that "fear rules the day, and we know that, so it's only logical to assume that we'll sell more EIAs when people are scared."

Sad but true.

Many investors I've talked to over the years tell me that they find it especially frustrating that no two EIAs are exactly alike, which is why apples-to-apples comparisons are next to impossible.  The same is true for performance comparison, even if two competing offerings are tracking an identical index, such as the S&P 500.

The bottom line on EIAs is that the returns you think you'll be getting if the markets rise may be nothing more than an illusion once all the contractual details are netted out. They're basically being sold as alternatives to stocks, when the reality is that they're much more of a bond-related instrument.

In the interest of fairness, EIAs have outperformed the S&P 500 over the last nine years, something Miguel Herce of CRA International points out in the January 2009 issue of Money magazine. But over time - 63% of the time since 1926, to be specific - the markets would have beaten EIAs.

Various studies reinforce this notion. One, in particular, conducted jointly by Dr. Craig McCann of UCLA and Dr. Dengpan Luo of Yale University, reflects that investors would be better off in a simple portfolio of U.S. Treasuries and large cap stocks - a whopping 97% of the time.

Boston University Economics Professor Laurence J. Kotlikoff summed it up nicely, noting in Money that "some of these products might pay off, but even a PhD in finance can't tell you if it's worth it because the returns are almost entirely at the discretion of the insurance company [that's offering the EIAs]."

Which is why we've never been big fan of these things.

But if the notion of a guaranteed return and all the market's upside strikes you as compelling right now - like it does us - here's a dramatically simpler and far less expensive way to achieve financial tranquility.

  • First, visit (or your local bank). When I checked, the company was offering Federal Deposit Insurance Corp. (FDIC) insured seven-year CD paying 5.05% APY through Capital One Financial Corp. (COF). Assuming you've got $20,000 to invest, you'll need to plop down ~$14,166.34 now to have $20,000 in seven years. (You can run whatever numbers you want using financial calculators available on the Internet).
  • Second, take the remaining $5,833.66 and buy the SPY exchange-traded fund (ETF), which tracks the S&P 500.

That's it. No extravagant fees. No surrender charges. And, most importantly, no upside-performance caps.

Plus, your investment is now guaranteed by the FDIC, which strikes me as a whole lot safer than a comparable EIA, which incidentally is only as good as the insurance company backing it. And lately, that's suspect to say the least.

Worst case scenario, you get your $20,000 back in seven years. Best case, if stocks recover from here and achieve 7% annually for the next seven years, you'll earn an additional $9,367.58, making your grand total $29,367.58.

What's more, because there's no complicated contract involved, you will understand what you're getting into from the get go, and will get to keep 100% of the potential gains to boot.

In closing, it's worth noting that EIAs are frequently touted as tax-advantaged investments in an attempt to make them more appealing. But if you simply buy the CD and the SPY in your IRA, you're achieving the much the same thing - but without the 9% commission.