The Power of the Annual Reset

Posted On: Monday, November 13, 2017

Certain investment vehicles that are used to generate retirement income utilize a mechanism known as the annual reset in determining the ongoing value of the investment. In short this means that each year, on the anniversary date of the investment, a percentage increase equal to overall gains in the market (based on a predetermined index such as the S&P 500) will be permanently credited to your investment value (often subject to some maximum amount or “cap”). If the market goes down during the year the value of your investment remains unchanged from the beginning of the year.

The result is that the value of your investment either stays the same or increases every year. Your annual gains are “locked in” and as the value of your investment increases you are safeguarded from ever sliding backwards.

Since your investment can never suffer a loss, the probability of realizing a gain over several years can be enhanced compared to an investment that can suffer actual losses (depending on market conditions).

Here is a quick example – You make an investment of $100,000 in a product that is measured by the S&P 500 index and is subject to a 10% cap. In year one the S&P 500 goes up by 20%. At the end of year one your investment value is $110,000. Then the S&P 500 goes down by 20% in year two. Your investment will still be worth $110,000 at the end of year two since you do not participate in market losses.

Compare this to an individual who has invested directly in the S&P 500. At the end of year 1 their investment value is $120,000. However, at the end of year two their investment is worth only $96,000 (they lost 20% of $120,000).

In addition, the starting point for measuring your gains for the next year is always reset to the value of the predetermined index at each anniversary date (i.e. the beginning of each new year). Therefore, a year in which the market has a large loss is not necessarily a bad thing. Your investment will not go down in value and the beginning measuring point for the year following the market loss is reset to that reduced value. As the market recovers its prior value your investment is rewarded with gains. This process is repeated year after year.

Here is another quick example –You make an investment of $100,000 in a product that is measured by the S&P 500 index and is subject to a 10% cap. In year one the S&P 500 goes down by 20% (2,000 to 1,600). At the end of year one your investment value is still $100,000 since you don’t participate in market losses. In addition, at the end of year one your measuring point for year two is reset to 1,600 (the value of the index at the anniversary date).

Then the S&P 500 goes back up to 2,000 in year two (a 25% gain). Your investment value will be $110,000 at the end of year two even though the S&P 500 began year one at 2,000 and ended year two at 2,000 (stayed the same over the two-year period).

The result is that even if the market has not had a large cumulative gain for several years, the value of your investment could still be significantly higher so long as there has been fluctuations in the market.

We look at the annual reset as an embodiment of the axiom “buy low and sell high”. When the market is low at any anniversary date that is your investment’s beginning measuring point for the following year (buy low). When the market is high at an anniversary date the value of your investment is permanently increased as a result of that high value (sell high), even though you don’t not have to sell the investment to capture those profits.

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