What Is Annuity Due?

An annuity due is an annuity whose payment is due immediately at the beginning of each period. A common example of an annuity due payment is rent, as landlords often require payment upon the start of a new month as opposed to collecting it after the renter has enjoyed the benefits of the apartment for an entire month.

How Annuity Due Works

An annuity due requires payments made at the beginning, as opposed to the end, of each annuity period. Annuity due payments received by an individual legally represent an asset. Meanwhile, the individual paying the annuity due has a legal debt liability requiring periodic payments.

Because a series of annuity due payments reflect a number of future cash inflows or outflows, the payer or recipient of the funds may wish to calculate the entire value of the annuity while factoring in the time value of money. One can accomplish this by using present value calculations.

A present value table for an annuity due has the projected interest rate across the top of the table and the number of periods as the left-most column. The intersecting cell between the appropriate interest rate and the number of periods represents the present value multiplier. Finding the product between one annuity due payment and the present value multiplier yields the present value of the cash flow.

A whole life annuity due is a financial product sold by insurance companies that require annuity payments at the beginning of each monthly, quarterly, or annual period, as opposed to at the end of the period. This is a type of annuity that will provide the holder with payments during the distribution period for as long as they live. After the annuitant passes on, the insurance company retains any funds remaining.

Annuity Due vs. Ordinary Annuity

An annuity due payment is a recurring issuance of money upon the beginning of a period. Alternatively, an ordinary annuity payment is a recurring issuance of money at the end of a period. Contracts and business agreements outline this payment, and it is based on when the benefit is received. When paying for an expense, the beneficiary pays an annuity due payment before receiving the benefit, while the beneficiary makes ordinary due payments after the benefit has occurred.

The timing of an annuity payment is critical based on opportunity costs. The collector of the payment may invest an annuity due payment collected at the beginning of the month to generate interest or capital gains. This is why an annuity due is more beneficial for the recipient as they have the potential to use funds faster. Alternatively, individuals paying an annuity due lose out on the opportunity to use the funds for an entire period. Those paying annuities thus tend to prefer ordinary annuities.

Examples of Annuity Due

An annuity due may arise due to any recurring obligation. Many monthly bills, such as rent, car payments, and cellphone payments, are annuities due because the beneficiary must pay at the beginning of the billing period. Insurance expenses are typically annuities due as the insurer requires payment at the start of each coverage period. Annuity due situations also typically arise relating to saving for retirement or putting money aside for a specific purpose.

How to Calculate the Value of an Annuity Due

The present and future values of an annuity due can be calculated using slight modifications to the present value and future value of an ordinary annuity.

Present Value of an Annuity Due

The present value of an annuity due tells us the current value of a series of expected annuity payments. In other words, it shows what the future total to be paid is worth now.

Calculating the present value of an annuity due is similar to calculating the present value of an ordinary annuity. However, there are subtle differences to account for when annuity payments are due. For an annuity due, payments are made at the beginning of the interval, and for an ordinary annuity, payments are made at the end of a period. The formula for the present value of an annuity due is:

With:

• C = Cash flows per period
• i = interest rate
• n = number of payments

Let’s look at an example of the present value of an annuity due. Suppose you are a beneficiary designated to immediately receive $1000 each year for 10 years, earning an annual interest rate of 3%. You want to know how much the stream of payments is worth to you today. Based on the present value formula, the present value is $8,786.11.

Future Value of an Annuity Due

The future value of an annuity due shows us the end value of a series of expected payments or the value at a future date.

Just as there are differences in how the present value is calculated for an ordinary annuity and an annuity due, there are also differences in how the future value of money is calculated for an ordinary annuity and an annuity due. The future value of an annuity due is calculated as:

Using the same example, we calculate that the future value of the stream of income payments to be $11,807.80.

Annuity Due FAQs

Which Is Better, Ordinary Annuity or Annuity Due?

Whether an ordinary annuity or an annuity due is better depends on whether you are the payee or payer. As a payee, an annuity due is often preferred because you receive payment up front for a specific term, allowing you to use the funds immediately and enjoy a higher present value than that of an ordinary annuity. As a payer, an ordinary annuity might be favorable as you make your payment at the end of the term, rather than the beginning. You are able to use those funds for the entire period before paying.

Often, you are not afforded the option to choose. For example, insurance premiums are an example of an annuity due, with premium payments due at the beginning of the covered period. A car payment is an example of an ordinary annuity, with payments due at the end of the covered period.

What Is an Immediate Annuity?

An immediate annuity is an account, funded with a lump sum deposit, that generates an immediate stream of income payments. The income can be for a stated amount (e.g., $1,000/month), a stated period (e.g., 10 years), or a lifetime.

How Do You Calculate the Future Value of an Annuity Due?

The future value of an annuity due is calculated using the formula:

where

• C = cash flows per period
• i = interest rate
• n = number of payments

What Does Annuity Mean?

An annuity is an insurance product designed to generate payments immediately or in the future to the annuity owner or a designated payee. The account holder either makes a lump sum payment or a series of payments into the annuity and can either receive an immediate stream of income or defer receiving payments until some time in the future, usually after an accumulation period where the account earns interest tax-deferred.

What Happens When an Annuity Expires?

Once an annuity expires, the contract terminates and no future payments are made. The contractual obligation is fulfilled, with no further duties owed from either party.

The Bottom Line

An annuity due is an annuity with payment due or made at the beginning of the payment interval. In contrast, an ordinary annuity generates payments at the end of the period. As a result, the method for calculating the present and future values differ. A common example of an annuity due is rent payments made to a landlord, and a common example of an ordinary annuity includes mortgage payments made to a lender. Depending on whether you are the payer or payee, the annuity due might be a better option.

What Is Appreciation?

Appreciation, in general terms, is an increase in the value of an asset over time. The increase can occur for a number of reasons, including increased demand or weakening supply, or as a result of changes in inflation or interest rates. This is the opposite of depreciation, which is a decrease in value over time.

How Appreciation Works

Appreciation can be used to refer to an increase in any type of asset, such as a stock, bond, currency, or real estate. For example, the term capital appreciation refers to an increase in the value of financial assets such as stocks, which can occur for reasons such as improved financial performance of the company.

Just because the value of an asset appreciates does not necessarily mean its owner realizes the increase. If the owner revalues the asset at its higher price on their financial statements, this represents a realization of the increase.

Another type of appreciation is currency appreciation. The value of a country’s currency can appreciate or depreciate over time in relation to other currencies.

How to Calculate the Appreciation Rate

The appreciation rate is virtually the same as the compound annual growth rate (CAGR). Thus, you take the ending value, divide by the beginning value, then take that result to 1 dividend by the number of holding periods (e.g. years). Finally, you subtract one from the result. 

 However, in order to calculate the appreciation rate that means you need to know the initial value of the investment and the future value. You also need to know how long the asset will appreciate.

For example, Rachel buys a home for $100,000 in 2016. In 2021, the value has increased to $125,000. The home has appreciated by 25% [($125,000 – $100,000) / $100,000] during these five years. The appreciate rate (or CAGR) is 4.6% [($125,000 / $100,000)^(1/5) – 1].

Appreciation vs. Depreciation

Appreciation is also used in accounting when referring to an upward adjustment of the value of an asset held on a company’s accounting books. The most common adjustment on the value of an asset in accounting is usually a downward one, known as depreciation.

Certain assets are given to appreciation, while other assets tend to depreciate over time. As a general rule, assets that have a finite useful life depreciate rather than appreciate.

Depreciation is typically done as the asset loses economic value through use, such as a piece of machinery being used over its useful life. While appreciation of assets in accounting is less frequent, assets such as trademarks may see an upward value revision due to increased brand recognition.

Real estate, stocks, and precious metals represent assets purchased with the expectation that they will be worth more in the future than at the time of purchase. By contrast, automobiles, computers, and physical equipment gradually decline in value as they progress through their useful lives.

Example of Capital Appreciation

An investor purchases a stock for $10 and the stock pays an annual dividend of $1, equating to a dividend yield of 10%. A year later, the stock is trading at $15 per share and the investor has received the dividend of $1.

The investor has a return of $5 from capital appreciation as the price of the stock went from the purchase price or cost basis of $10 to a current market value of $15. In percentage terms, the stock price increase led to a return from capital appreciation of 50%. The dividend income return is $1, equating to a return of 10% in line with the original dividend yield. The return from capital appreciation combined with the return from the dividend leads to a total return on the stock of $6 or 60%.

Example of Currency Appreciation

China’s ascension onto the world stage as a major economic power has corresponded with price swings in the exchange rate for its currency, the yuan. Beginning in 1981, the currency rose steadily against the dollar until 1996, when it plateaued at a value of $1 equaling 8.28 yuan until 2005. The dollar remained relatively strong during this period. It meant cheaper manufacturing costs and labor for American companies, who migrated to the country in droves.

It also meant that American goods were competitive on the world stage as well as the U.S. due to their cheap labor and manufacturing costs. In 2005, however, China’s yuan reversed course and appreciated 33% in value against the dollar. As of May 2021, it’s still near that retraced level, trading at 6.4 yuan.

Appreciation FAQs

What Is an Appreciating Asset?

An appreciating asset is any asset which value is increasing. For example, appreciating assets can be real estate, stocks, bonds, and currency.

What Is Appreciation Rate?

Appreciation rate is another word for growth rate. The appreciation rate is the rate at which an asset’s value grows.

What Is a Good Home Appreciation Rate?

A good appreciation rate is relative to the asset and risk involved. What might be a good appreciation rate for real estate is different than what is a good appreciation rate for a certain currency given the risk involved.

What Is Meant by Capital Appreciation?

Capital appreciation is the increase in the value or price of an asset. This can include stocks, real estate, or the like.  

The Bottom Line

Appreciation is the rise in the value of an asset, such as currency or real estate. It’s the opposite of depreciation, which reduces the value of an asset over its useful life. Increases in value can be attributed to interest rate changes, supply and demand changes, or various other reasons. 

What Is an Assignment?

Assignment most often refers to one of two definitions in the financial world:

1. The transfer of an individual’s rights or property to another person or business. This concept exists in a variety of business transactions and is often spelled out contractually.
2. In trading, assignment occurs when an option contract is exercised. The owner of the contract exercises the contract and assigns the option writer to an obligation to complete the requirements of the contract.

Property Rights Assignment

Assignment refers to the transfer of some or all property rights and obligations associated with an asset, property, contract, etc. to another entity through a written agreement. For example, a payee assigns rights for collecting note payments to a bank. A trademark owner transfers, sells, or gives another person interest in the trademark. A homeowner who sells their house assigns the deed to the new buyer.

To be effective, an assignment must involve parties with legal capacity, consideration, consent, and legality of object.

Examples

A wage assignment is a forced payment of an obligation by automatic withholding from an employee’s pay. Courts issue wage assignments for people late with child or spousal support, taxes, loans, or other obligations. Money is automatically subtracted from a worker’s paycheck without consent if they have a history of nonpayment. For example, a person delinquent on $100 monthly loan payments has a wage assignment deducting the money from their paycheck and sent to the lender. Wage assignments are helpful in paying back long-term debts.

Another instance can be found in a mortgage assignment. This is where a mortgage deed gives a lender interest in a mortgaged property in return for payments received. Lenders often sell mortgages to third parties, such as other lenders. A mortgage assignment document clarifies the assignment of contract and instructs the borrower in making future mortgage payments, and potentially modifies the mortgage terms.

A final example involves a lease assignment. This benefits a relocating tenant wanting to end a lease early or a landlord looking for rent payments to pay creditors. Once the new tenant signs the lease, taking over responsibility for rent payments and other obligations, the previous tenant is released from those responsibilities. In a separate lease assignment, a landlord agrees to pay a creditor through an assignment of rent due under rental property leases. The agreement is used to pay a mortgage lender if the landlord defaults on the loan or files for bankruptcy. Any rental income would then be paid directly to the lender.

Options Assignment

Options can be assigned when a buyer decides to exercise their right to buy (or sell) stock at a particular strike price. The corresponding seller of the option is not determined when a buyer opens an option trade, but only at the time that an option holder decides to exercise their right to buy stock. So an option seller with open positions is matched with the exercising buyer via automated lottery. The randomly selected seller is then assigned to fulfill the buyer’s rights. This is known as an option assignment.

Once assigned, the writer (seller) of the option will have the obligation to sell (if a call option) or buy (if a put option) the designated number of shares of stock at the agreed-upon price (the strike price). For instance, if the writer sold calls they would be obligated to sell the stock, and the process is often referred to as having the stock called away. For puts, the buyer of the option sells stock (puts stock shares) to the writer in the form of a short-sold position.

Example

Suppose a trader owns 100 call options on company ABC’s stock with a strike price of $10 per share. The stock is now trading at $30 and ABC is due to pay a dividend shortly. As a result, the trader exercises the options early and receives 10,000 shares of ABC paid at $10. At the same time, the other side of the long call (the short call) is assigned the contract and must deliver the shares to the long.

What Is Alpha?

Alpha (α) is a term used in investing to describe an investment strategy’s ability to beat the market, or its “edge.” Alpha is thus also often referred to as “excess return” or “abnormal rate of return,” which refers to the idea that markets are efficient, and so there is no way to systematically earn returns that exceed the broad market as a whole. Alpha is often used in conjunction with beta (the Greek letter β), which measures the broad market’s overall volatility or risk, known as systematic market risk.

Alpha is used in finance as a measure of performance, indicating when a strategy, trader, or portfolio manager has managed to beat the market return over some period. Alpha, often considered the active return on an investment, gauges the performance of an investment against a market index or benchmark that is considered to represent the market’s movement as a whole.

The excess return of an investment relative to the return of a benchmark index is the investment’s alpha. Alpha may be positive or negative and is the result of active investing. Beta, on the other hand, can be earned through passive index investing.

Understanding Alpha

Alpha is one of five popular technical investment risk ratios. The others are beta, standard deviation, R-squared, and the Sharpe ratio. These are all statistical measurements used in modern portfolio theory (MPT). All of these indicators are intended to help investors determine the risk-return profile of an investment.

Active portfolio managers seek to generate alpha in diversified portfolios, with diversification intended to eliminate unsystematic risk. Because alpha represents the performance of a portfolio relative to a benchmark, it is often considered to represent the value that a portfolio manager adds to or subtracts from a fund’s return.

In other words, alpha is the return on an investment that is not a result of a general movement in the greater market. As such, an alpha of zero would indicate that the portfolio or fund is tracking perfectly with the benchmark index and that the manager has not added or lost any additional value compared to the broad market.

The concept of alpha became more popular with the advent of smart beta index funds tied to indexes like the Standard & Poor’s 500 index and the Wilshire 5000 Total Market Index. These funds attempt to enhance the performance of a portfolio that tracks a targeted subset of the market.

Despite the considerable desirability of alpha in a portfolio, many index benchmarks manage to beat asset managers the vast majority of the time. Due in part to a growing lack of faith in traditional financial advising brought about by this trend, more and more investors are switching to low-cost, passive online advisors (often called roboadvisors​) who exclusively or almost exclusively invest clients’ capital into index-tracking funds, the rationale being that if they cannot beat the market they may as well join it.

Moreover, because most “traditional” financial advisors charge a fee, when one manages a portfolio and nets an alpha of zero, it actually represents a slight net loss for the investor. For example, suppose that Jim, a financial advisor, charges 1% of a portfolio’s value for his services and that during a 12-month period Jim managed to produce an alpha of 0.75 for the portfolio of one of his clients, Frank. While Jim has indeed helped the performance of Frank’s portfolio, the fee that Jim charges is in excess of the alpha he has generated, so Frank’s portfolio has experienced a net loss. For investors, the example highlights the importance of considering fees in conjunction with performance returns and alpha.

The Efficient Market Hypothesis (EMH) postulates that market prices incorporate all available information at all times, and so securities are always properly priced (the market is efficient.) Therefore, according to the EMH, there is no way to systematically identify and take advantage of mispricings in the market because they do not exist.

If mispricings are identified, they are quickly arbitraged away and so persistent patterns of market anomalies that can be taken advantage of tend to be few and far between.

Empirical evidence comparing historical returns of active mutual funds relative to their passive benchmarks indicates that fewer than 10% of all active funds are able to earn a positive alpha over a 10-plus year time period, and this percentage falls once taxes and fees are taken into consideration. In other words, alpha is hard to come by, especially after taxes and fees.

Because beta risk can be isolated by diversifying and hedging various risks (which comes with various transaction costs), some have proposed that alpha does not really exist, but that it simply represents the compensation for taking some un-hedged risk that hadn’t been identified or was overlooked.

Seeking Investment Alpha

Alpha is commonly used to rank active mutual funds as well as all other types of investments. It is often represented as a single number (like +3.0 or -5.0), and this typically refers to a percentage measuring how the portfolio or fund performed compared to the referenced benchmark index (i.e., 3% better or 5% worse).

Deeper analysis of alpha may also include “Jensen’s alpha.” Jensen’s alpha takes into consideration the capital asset pricing model (CAPM) market theory and includes a risk-adjusted component in its calculation. Beta (or the beta coefficient) is used in the CAPM, which calculates the expected return of an asset based on its own particular beta and the expected market returns. Alpha and beta are used together by investment managers to calculate, compare, and analyze returns.

The entire investing universe offers a broad range of securities, investment products, and advisory options for investors to consider. Different market cycles also have an influence on the alpha of investments across different asset classes. This is why risk-return metrics are important to consider in conjunction with alpha.

Examples

This is illustrated in the following two historical examples for a fixed income ETF and an equity ETF:

The iShares Convertible Bond ETF (ICVT) is a fixed income investment with low risk. It tracks a customized index called the Bloomberg U.S. Convertible Cash Pay Bond > $250MM Index. The 3-year standard deviation was 18.94%, as of Feb. 28, 2022. The year-to-date return, as of Feb. 28, 2022, was -6.67%. The Bloomberg U.S. Convertible Cash Pay Bond > $250MM Index had a return of -13.17% over the same period. Therefore, the alpha for ICVT was -0 12% in comparison to the Bloomberg U.S. Aggregate Index and a 3-year standard deviation of 18.97%.

However, since the aggregate bond index is not the proper benchmark for ICVT (it should be the Bloomberg Convertible index), this alpha may not be as large as initially thought; and in fact, may be misattributed since convertible bonds have far riskier profiles than plain vanilla bonds.

The WisdomTree U.S. Quality Dividend Growth Fund (DGRW) is an equity investment with higher market risk that seeks to invest in dividend growth equities. Its holdings track a customized index called the WisdomTree U.S. Quality Dividend Growth Index. It had a three-year annualized standard deviation of 10.58%, higher than ICVT.

As of Feb. 28, 2022, DGRW annualized return was 18.1%, which was also higher than the S&P 500 at 16.4%, so it had an alpha of 1.7% in comparison to the S&P 500. But again, the S&P 500 may not be the correct benchmark for this ETF, since dividend-paying growth stocks are a very particular subset of the overall stock market, and may not even be inclusive of the 500 most valuable stocks in America.

Alpha Considerations

While alpha has been called the “holy grail” of investing, and as such, receives a lot of attention from investors and advisors alike, there are a couple of important considerations that one should take into account when using alpha.

1. A basic calculation of alpha subtracts the total return of an investment from a comparable benchmark in its asset category. This alpha calculation is primarily only used against a comparable asset category benchmark, as noted in the examples above. Therefore, it does not measure the outperformance of an equity ETF versus a fixed income benchmark. This alpha is also best used when comparing the performance of similar asset investments. Thus, the alpha of the equity ETF, DGRW, is not relatively comparable to the alpha of the fixed income ETF, ICVT.
2. Some references to alpha may refer to a more advanced technique. Jensen’s alpha takes into consideration CAPM theory and risk-adjusted measures by utilizing the risk-free rate and beta.

When using a generated alpha calculation it is important to understand the calculations involved. Alpha can be calculated using various different index benchmarks within an asset class. In some cases, there might not be a suitable pre-existing index, in which case advisors may use algorithms and other models to simulate an index for comparative alpha calculation purposes.

Alpha can also refer to the abnormal rate of return on a security or portfolio in excess of what would be predicted by an equilibrium model like CAPM. In this instance, a CAPM model might aim to estimate returns for investors at various points along an efficient frontier. The CAPM analysis might estimate that a portfolio should earn 10% based on the portfolio’s risk profile. If the portfolio actually earns 15%, the portfolio’s alpha would be 5.0, or +5% over what was predicted in the CAPM model.