     
Bells
and Whistles
I
went to lunch today with a highly trained, highly compensated, extremely
experienced professional. He was an annuity wholesaler. (For those
that know me, you must be wondering why I would spend any time with
an annuity guy. Everyone knows how I feel about annuities and their
limited investment choices and their high tax rates.)
The
Pitch
This guy was as nice and professional as can be. Smooth. Probably
a great neighbor, father and husband. And that is why I had lunch
with him - to hear for myself the types of things investors hear.
I
could see how people fall for his great stories and effortless delivery.
His presentation was flawless. I was amazed at his very practiced
technique that came across so conversational. Our dialogue was almost
scripted. I would answer his questions just the way he wanted me
to.
What
I came away with was a deeper concern for the investing public.
This guy was good and there are many, many others out there just
like him. They use key words that get investors all weak-in-the-knees.
Words like “guaranteed” and “insured” and
“income for life”. They ask questions to which the only
answer is to agree – “You do want to provide for your
spouse, don’t you?” or “You would like an income
for life, wouldn’t you?”
The
Sizzle
And then the options, choices and unique features of the various
annuities are enough to confuse and bewilder the most seasoned of
investors (and many professionals!) You can get a lifetime income,
or guaranteed principal or a step-up in value and there are bonuses,
but not if you do the first 2 options unless you choose automatic
rebalancing, in which case you can’t do the systematic withdrawal
except on Tuesdays… It is confusing, and I think it is meant
to be that way.
The
Hook
But the big thing, the single biggest selling point is the guarantee.
Years ago, the “guarantee” was the high value of the
contract as a death benefit. Now you have a choice of having the
high value locked in every 3 years, or once a year after a certain
number of years or a fixed guarantee for a certain number of years.
The options are almost endless, except for one - if you want to
employ the guarantees, you have to make limited withdrawals for
years. You don’t get to cash the whole thing in.
This
sounds fine when you are putting money into the annuity. But speaking
as someone that has many retired clients, I can assure you that
there are times when you want to access more than 5% of your money
annually. But once you have chosen to take distributions, you can’t
go back and try to access the rest of your money. Oops!
And
what if you need more than whatever fixed rate they offer? Sorry
about that too. You wanted an income for life. They never said it
would be “enough” income!
Widespread
technique
This isn’t only an annuity issue. I see this same phenomenon
in 401(k)s and 529 plans. Wall Street has loaded these products
full of extra features meant to dazzle and entice you. There are
401(k)’s that have automatic rebalancing, daily switches and
pre-allocated portfolios. Some will even pick up your dry cleaning!
529 plans boast about tax benefits, estate planning advantages and
high contribution limits.
Performance?
No, look at the benefits some more…
Funny, few of them ever talk about performance or investment risk.
With annuities, they talk up the guaranteed aspect so much, risk
becomes irrelevant. Even though investment risk is real. The guarantees
don’t eliminate it. And because they talk so much about the
guarantees, investment performance becomes secondary. In fact, one
guy refers to any gains the investment might generate as “gravy”
on top of all the guarantees. (I thought the primary objective of
investing was for investment performance. I must be old school!)
How
do they measure success? Ka-Ching!
What they do talk about is the barrels full of cash being put into
these plans. They measure success by the amount of money the plans
attract. Tens of billions are being put into 529 plans annually.
Tens of billions are also being put into variable annuity products
with some sort of guarantee to them. 401k’s haven’t
lost their luster at all over the past few years.
Success
isn’t measured by investment performance, it is measured by
deposits into the plan. “It must be good if so many people
are buying it” is the attitude. (Didn’t billions also
go into internet stocks and other questionable IPOs a few years
ago?)
And
a broker is successful if he makes a lot of money. Not if his clients
make money, since everybody knows, you can’t control the markets.
The best you can do is invest like everybody else and hope for the
best. Investment performance doesn’t come into the formula
for a broker’s success.
If
it sounds too good to be true…
What is the downside? Investors hear the word “guarantee”
and that is all they hear. They stop listening after that. They
have heard the magic word. Most annuity contracts have all sorts
of addendums, riders and conditions that the average investor will
not remember - like the only way you can get the guarantee is if
you take the fixed amount per year as income.
Once
an investor annuitizes, they are locked in, they no longer have
access to their money. They are stuck with whatever the cash flow
is, even if it isn’t enough to live on.
What
if the insurance company fails?
But it is all of these guarantees that are the most concerning.
Who guarantees these products? There are billions of dollars in
annuities with many various degrees of guarantees. I’m told
it is through re-insurance at some firms, lines of credit at others
and sophisticated hedging techniques at others.
Some
of these guarantees last years, even decades. Will the insurance
company that is re-insuring the annuities be willing to pay out
potentially billions of dollars if the markets go against the annuities
and the insurance companies find themselves on the hook to the investors?
Will the banks that back some of these products be so inclined to
keep a line of credit open to an insurance company that is having
trouble in its investment portfolios? The hedging techniques are
the only logical way to offer guarantees, but even these have market
risks that are unforeseen. Just ask the fellas at Long Term Capital.
They were Nobel Laureates in economics and even they blew up because
their sophisticated hedging techniques didn’t work.
Benefits
are good, but the investment performance should be the primary issue.
I’m not against usable features. But investors are hearing
only the bells and whistles and are pouring billions into investments
that maybe they shouldn’t be involved in. Call me boring,
old school or unexciting, but I’ll stick with the fundamentals
and pass on the ancillary features. Investing is supposed to be
about investing, not all these zippity-doo, wiz-bang extras.
(Required
disclosure - Before investing, consider investment objectives, risks,
charges and expenses of the annuity and its investment options.
Principal value, income payments and investment returns of a vraible
annuity will fluctuate, and you may have a gain or a loss when money
is received. For this and other information, call the insurance
or fund company for a free propsectus. Please read it carefully.)
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