Kimmunications

Variable Life Insurance & Annuities: Investment Scandals in Waiting

The following is from Steve Selengut, portfolio manager and author of "The Brainwashing of America". He put it up as a comment to my post, "NASD continues probe into abusive sales practices of variable annuities." I thought it was worthy of its own post. See what you think.

 

 

We humans are as creative on the "Dark Side" of commercial activity as we are in developing beneficial new products and services. In the face of huge financial benefits, however, some corporate executives can't resist taking an extra dessert even before their shareholders have finished dinner. Some scandals have more of an impact on investors than others, and most produce unwarranted layers of government regulation and control that stifle honest creativity.

 

Plain vanilla fraud and theft are less worrisome to me than situations where the general acceptance of misinformation or "business as usual" practices allows inherently bad product ideas and blatant mismanagement to become accepted by regulatory authorities, financial professionals, and myopically gullible consumers. Here are some candidates for future "Blockbuster Scandal Awards" (B S Awards, if you will): Variable Life Insurance & Annuities, Wrap Fee Managed Investment Accounts, Portfolio Window Dressing, Asset Allocation Mutual Funds, and Obscene Executive Compensation.

 

1) Variable Insurance and Annuities: Variable products are a relatively new thing in the insurance industry, circa 1980 or so. Before that, the conventional wisdom labeled the Shock Market much too risky for Life Insurance Policy and Annuity Contract guaranteed benefits. In fact, these benefits had been "guaranteed" for so long that it became a generic expectation of anyone in the market for either. So why did the State Insurance departments cave in to the Variable Product lobby? And what is not emphasized as these products are marketed to potential insureds and annuitants?

 

As if the 8% sales commission on Straight Life Annuities wasn't enough, the addition of Mutual Fund bonuses made the Variable Annuity irresistible... to financial professionals. Similarly, this product is so lucrative for the companies that they manipulate their rates to become more competitive. Since the introduction of variable benefits, there have been more insurance company failures and scandals, and not just a few disappointed recipients of reduced annuity payments. What's in your retirement plan?

 

2)Wrap Fee Investment Accounts: From the very beginnings of wealth, the very wealthy employed Investment Managers to protect and to grow their portfolios. Most Investment Managers had just a few huge clients that they tended to while the rest of the fledging financial industry focused on property protection and estate creation through life insurance. Most of today's (salaried) Investment Managers are employed by Financial Institutions to supervise thousands of Mutual Funds for millions of investors of all financial shapes and sizes. There are more Equity Mutual Funds than there are individual Equities on the New York Stock Exchange. Most investors today will employ many Investment Managers and never actually speak to any of them.

 

Enter the personally managed investment portfolio product offered by most major Financial Institutions. For a single fee, you receive the personal services of a professional Investment Manager, and a portfolio specifically designed for you. Except, of course, that you get neither. You get precisely the same portfolio as everybody else, and all at once regardless of price... a Mutual Fund with individual statements. But of course, you can speak to the manager any time you like, change your asset allocation, set aside a reserve for an upcoming expenditure, etc. Yeah, sure you can!

Note that "Flat Fee" managed accounts are quite different and may actually be separately and personally managed.

 

3)Portfolio Window Dressing: Every quarter, every year, we hear about the adjustments that portfolio managers are making as they attempt to look smart to their largest clients. Now in a discipline (Investing) that they all officially recognize as a long-term commitment to some specific strategy or plan, why do the Masters of the Universe spend so much time manipulating their short-term performance numbers? And why is this considered business as usual instead of common fraud?

 

4)Asset Allocation Mutual Funds: I look at Asset Allocation a bit differently than most professionals seem to and I regulate and monitor a portfolio's structure using the cost basis of securities rather than their Market Value. But how, logically, can a one-size-fits-all Mutual Fund be the right mix for all investors? Here's a definition found on the Internet: "A mutual fund that rotates among stocks, bonds, and money market securities to maximize return on investment and minimize risk". And a definition of Asset Allocation from a similar source: "The practice of distributing a certain percentage of a portfolio between different types of investment assets, such as stocks, bonds, mutual funds, cash, real estate, options, etc. By diversifying an individual's asset base, one hopes to create a favorable risk/reward ratio for a portfolio".

 

In reality, Asset Allocation is a structure-planning tool that determines what percentage of an Investment Portfolio is to be invested for Growth in Equity securities and what percentage is to be invested for income production. The proper allocation is a function of the investor's age, marital status, financial position, employment status, retirement plans, expenditure needs, risk tolerance, family responsibilities, etc. Diversification occurs within the two (just two) asset classes. One size fits all... who's kidding whom?

 

5) Corporate Executive Compensation: I strongly believe that everyone has the right to become filthy rich, legally of course. I respect anyone who gets there honestly because their success creates jobs, opportunities, wealth, and a higher standard of living for everyone. But, once they sell shares of their successful enterprises to the public, they have a responsibility to share future profits and growth. Obscene executive suite compensation (right down to the chauffeured limousines) is simply stealing from shareholders.

 

With every new Scandal, a voracious Media and a hypocritical Congress exacerbate the fear of shocked investors and call for more regulation of the very entities whose success, freedom, viability, and competitiveness they should be nurturing. Ironically, politicians are always the most outspoken critics... probably because of their familiarity with cover-ups and improprieties. But no one ever questions the integrity of the Financial Institutions that invent, produce, price, and promote products and services that do far more long-term harm than the few (albeit serious and sensational) incidents of corporate wrong doing.

 

Four of the five candidates for this year's Blockbuster Scandal (B S) Award were created on Wall Street. The fifth is ignored by it. Which one bothers you most?

 

Your thoughts and comments are welcome, as always. Please leave them below.

Annuities: Fixed or Variable, Immediate or Deferred?

I began questioning how many people understand the difference between different types of annuities after I received an email this week from one of my Snider Investment Method™ Workshop graduates. Annuities come in a thousand different flavors and colors. No two are exactly alike.

 

I think most people lump them together without understanding the difference. Or maybe they just think I automatically think all annuities are bad. That is not true. I think MOST annuities are bad and the rest have very limited application.

 

Annuities are basically either fixed or variable and either immediate or deferred. Beyond that, the permutations become endless. That is one of their drawbacks. They are very complicated, almost impossible to compare apples to apples, and very few people understand what they are buying when they buy them. Nowhere in the investment world is buyer's remorse more prevalent, in my experience, than with buyers of annuities.

 

A fixed annuity is an insurance contract that promises you, or you and your spouse, a predetermined income for as long as you live--no matter how long that might be. For example, you pay the insurance company a lump sum of $100,000, say, and they promise you $3,000 to $6,000 a year for the rest of your life.

 

The advantage of a fixed annuity is that it provides you with a guaranteed cash flow indefinitely - provided, of course, the insurance company remains solvent. If you live a long time after buying the annuity, you may even receive more in payments than you put in. The second advantage is its consistency. You know exactly how much you are going to get. The amount does not fluctuate with market conditions or interest rates.

 

The downside is, when you die, the remainder of your initial payment belongs to the insurance company. Your heirs get nothing. Another disadvantage is that most fixed annuities are just that - fixed. The amount you receive each year remains constant so the purchasing power is eaten away, over time, by inflation. Finally, it is highly likely that even a conservative investor can get far better returns than the annuity.

 

When is a fixed annuity appropriate? The only time a fixed annuity makes sense to me is for an extremely risk-averse investor. An example would be someone who has almost no retirement savings, no other sources of income, and for whom the loss of even a single dollar would be catastrophic. Even then, the problem I have is you can do so much better with just a smidgeon of extra risk using CDs and bonds.

 

A variable annuity, on the other hand, is very different. The initial investment is invested in a range of investment options, usually mutual funds, called subaccounts. The amount of money you receive is, as the name implies, variable, and is based on the performance of the investments.

 

Variable annuities are generally reviled by all but those who sell them. The problems are legion and I won't go into them here. If you are interested, you can check out my previous posts on the subject, my interview with Gary Schatsky, chairman emeritus of the National Association of Financial Planners on the subject, or get a quick run down of the problem from two good articles here and here.

 

I never, ever, ever recommend a variable annuity. Bring on the angry email from the insurance salesmen. I don’t care. You can’t convince me otherwise.

 

The other characteristic of annuities is immediate versus deferred. An immediate annuity begins paying out immediately.

 

A deferred annuity has an accumulation phase and a payout phase. During the accumulation phase, you contribute to the annuity and hopefully give the principal time to grow. When you reach retirement age, you can elect to annuitize the principal, in which case you would begin receiving regular periodic payments, like a fixed annuity, or you can request a lump sum distribution.

 

While I admit there may be specific scenarios in which an annuity makes some sense, my general advice is, be they fixed or variable, immediate or deferred, annuities are an investment you can probably do without.

09-27-2006: Items of interest for the Family CFO

Yet another example that no one can predict the future direction of stock prices and reading the news on those stocks will cause you to buy when you should be selling and sell when you should be buying. Take a look at the news headlines from 1995-97 about Apple. (Tip of the hat to Barry Ritholtz of The Big Picture for this one.)

 

Health insurance continues to be the x factor in the future standard of living for many Americans. The New York Times (free subscription required) says the cost of insuring a family rose 7.7% last year. That is double the cost from seven years ago. It is also double the rate of wage increases and inflation.

 

Walter Updegrave, senior editor at Money Magazine (and previous guest on my radio show) lays out some of the reasons you should avoid annuities in 3 Retirement Deals You Can Do Without. He gives the sales pitch for equity indexed annuities, IRA rollover annuities and annuity swaps. Then he does a nice job of telling you what the pitch leaves out. (Thanks to Snider Investment Method™ graduate Taylor Stevens for the heads up on this one.)

 

Paul Farrell, of MarketWatch.com, illustrates one of the fundamental problems with investing: we are human. Being human, our brains play all sorts of dastardly tricks on us. One such trick is filtering out information that doesn't support our point of view. We all do it. It is one of the reasons why I say, when it comes to investing, we are our own worst enemy. We think we are being logical when really we make decisions in a totally illogical way, most of the time.

 

If you see something you think would be of interest to other Family CFOs, please pass it on. You can email it to me: kim (at) kimsnider.com. As always, your thoughts on these or any other topics are welcome. Leave them below.

Ditch your money manager

Everybody focuses so much time and attention on minimizing taxes. But guess what? Taxes aren't the biggest drain on your returns. It's the fees and commissions being collected by those same advisors who are talking about all those nasty taxes. The fact is you'll pay four times more to your fund manager than you will to Uncle Sam in taxes. How, you might ask?

 

This is how: suppose you and your wife don't have any dependents when you reach retirement and you're at that 1 million mark and you decide you can live off $40,000 a year. And suppose the $40,000 is ordinary income so you'll have to take the standard deduction. The government gets around $4000 but your money manager will get four times that amount.

 

You see the fund industry gets about 1.60 percent in expenses from you - the consumer - in order to pay for things like marketing, taxes, tools and the occasional piece of advice. You and your spouse will be paying your friendly fund manager $16,000 every year based on your million dollar portfolio. That's four times what you're paying in federal taxes! And for what? Certainly not for performance since two-thirds of all actively managed funds under-perform the benchmark indexes.

 

Now let's pretend you and your spouse have an investment advisor in addition to your mutual fund manger and he's convinced you to wrap up your retirement assets in a high-commission insurance product like a variable annuity. Remember that expense ratio of 1.60? Well, it could climb to as much as 2.50 percent or more!

 

Now you and your partner are paying an outlandish $25,000 a year to your fund manager and advisor to manage a portfolio that could be managed by you, with better results, for next to nothing. $25K is over HALF of what you've taken out to live on every year. I don't know about you, but retirement is supposed to be fun and engaging and I can have a lot more fun on $65,000 than I can on $40,000.

 

The saddest part is that's about $20,000 more than what you really have to pay. So why do brokers and financial advisors continue to harp on taxes and never on fees? It doesn't take a rocket scientist to figure that one out, does it? It's a canard - a smoke screen - and we fall for it!

 

Now look, I'm not pointing fingers at you. Many of you know that I went from rags to riches back to rags again in less than two years because I didn't know what was going on in my portfolio. Like many of you, I trusted my broker to handle my money partly because I believed he was more qualified than I was to do it. That assumption cost me a whole lot of money.

 

The fastest way to improve the returns in your portfolio without taking on one ounce of additional risk is to lower your fees. The best way to lower your fees is to ditch your money managers. You don't need them, and in spite of what you might think, you don't have to spend countless hours to do manage your own money.

 

Let me know if you agree or disagree. Do you think your money managers are worth what you pay them? Do you really know how much you pay them? Leave your thoughts and comments below.

Financial Advisor Symposium: Choosing Which Retirement Account to Tap First

Choosing Which Retirement Account to Tap First

2nd Annual Financial Advisor Symposium - Las Vegas, NV

Saturday, April 28, 2006

 

 

David Carter, President, Carter Asset Management, Inc.

 

There is NO one formula that fits everyone's solution.

 

Some Deciding Factors in Choosing Which To Tap First

Qualified accounts and tax sheltered annuities will be taxed as ordinary income

Dividends and long term capital gains are taxed at 15%

Tax on social security benefit

Roth IRA money is not taxable

Is client over 70 1/2 and into required minimum distributions

Is client under 591/2 and taking 72(t) distributions

Clients desire to reduce income for their decedents

Clients desire to leave an estate for charity or heirs

 

Some people are really resistant to taking RMD's but if you look at the tables, the amounts are really very low that you are required to withdraw

 

Fredrick Adkins, CEO, Arkansas Financial Group

 

What's deducted?

What's taxed?

How is it taxed?

 

The problem with tax deferred accounts is they convert long term capital gains and dividends to ordinary income that could be taxed as high as 35% in the top tax bracket. Variable annuities do the same thing. Tax deferral is a "sucker bet"

 

Asset classes that were shunned in the accumulation phase are now favored in the distribution phase.

 

Peter Lynch, years ago, got a lot of press for suggesting that you should never own bonds in an investment portfolio. When you got to distribution, you just took capital gains and lived on those. Anyone who followed that advice was devastated in 2000 - 2002.

 

If you put qualified versus non-qualified on a pie chart and equity versus fixed income on another chart, the closer those two charts match up, the easier distributions are. Ideally you would prefer equities in the non-qualified and fixed income to match up to the qualified.

 

Bond interest is tax neutral - it is taxed the same whether it comes form qualified or non-qualified accounts. (True of Snider Method income as well.) That is not true with equities. Rule of thumb is to take fixed income assets first and move towards equity.

 

Gregory Sullivan, President, Sullivan, Bruyette, Speros & Blayney, Inc.

 

There is a world of difference between a plan that assumes linear returns, in other wrods, just takes the average return and running it out to some estiamted longevity number. In the scenario Greg showed, using the average return, the client could live to 95 and still have 1.2M left.

 

But if you run a Monte Carlo simulation, which takes into account volatility, or non-linear returns, there is a very real possibility that same client could run out of money, even while achieving the average assumed in the linear. As I demonstrate in all my speeches and information sessions, this is the hidden cost of risk.

 

If you simply look at taxes, you may get the wrong answer. It is a broader question than tax. Letting tax rule the decision making could run the client out of money.

 

If you have a $1M IRA and a $1M taxable account, you cannot have the advisor withdraw the fees for both from the IRA. IF the fee was $10K per, and you withdrew $20K from the IRA, $10K of it would be considered a withdrawal. In the other hand, you could take all $20K from the taxable to pay fees on both. It goes one way but not the other.

 

Interesting side note, all three speakers were adamantly opposed to the use of variable annuities.

Beware Wolves in Sheep's Clothing

Every investor today must wrestle with the problem of how to create enough low-risk income during their retirement. In years gone by, this income was guaranteed by government entitlement programs and employer sponsored pensions. ERISA changed all that. Since Congress passed ERISA in the 1980's, the burden of retirement income has shifted almost completely from employer to employee. Today, less than 18% of American workers are covered by a defined benefit plan.

 

For years, I have been writing about why I think variable annuities are terrible investments. The costs are too high, the sub-accounts perform poorly, your money is locked up for years with a penalty for withdrawal and they are taxed as ordinary income when the money is withdrawn.

 

For awhile, variable annuity sales climbed in spite of these problems. Annuity salesmen preyed on the fears created during the 2001 - 2002 decline in the stock market to breathe new life into annuity sales. Fortunately, people are beginning to wise up.

 

VARDS founder Rick Carey predicts a 50 percent decline in 2005 variable annuity sales over the previous year, once the final figures come out. "The VA business is exhibiting classic S-curve behavior, signifying a stagnant business," Carey says. "If the entire industry were a single insurance company, it wouldn't be long before it would be out of business."

 

In yet another ploy to spin variable annuities, insurance companies are now dressing them up as "personal pension plans." In 2004, MetLife rolled out Personal Pension Builder. Genworth Financial has created ClearCourse and New York Life will soon be releasing Personal Pension.

 

Joseph Belth, professor emeritus of insurance at Indiana University warns against getting caught up in the marketing hype. "They're renaming things with jazzy names...that aren't that much different than what has been offered in the industry over the last 50 years."

 

Financial engineers are working feverishly to invent new investments to meet the income needs of retirees. These investments have low costs, better performance, more transparency and, in some cases (like mine), investor control.

 

Control is a huge issue in retirement planning. Dan Danford of the Family Investment Center in St. Joseph, Mo., says, "From my viewpoint, the last thing the average boomer needs is to lock in payments they'll be forced to live with another 30 years! Would any of us want to live in the same house we bought 30 years ago? If we had developed a budget 30 years ago, could we have envisioned new cars costing $30,000 apiece, or gasoline at almost $3 a gallon?"

 

Flexibility and control of assets are essential, in my opinion, for successfully navigating the financial markets before and during a 30 year retirement. What are your thoughts? As always, you can leave them below.

 

TIP OF THE HAT:

 

Thanks to Snider Method Workshop alumni Mike McCorstin for pointing out the Wall Street Journal article on "personal pensions".

 

SOURCES:

 

1. Tom Lauricella. "The Latest Pension Substitute." Wall Street Journal 11 February 2006, B1.

 

2. David Drucker. "Breaking the Rules." Financial Advisor March 2006, p101.

http://www.fa-mag.com/issues.php?id_content=2&idArticle=1176

 

3. John Sullivan. "Fear and Greed." Boomer Market Advisor February 2006, p10.

Managing Retirement Income Conference

I promised to blog from the Second Annual Managing Retirement Income Conference that I attended at the end of February. I broke my promise!

 

I have received several emails saying you are waiting - with baited breath -to find out what was new in the world of managing retirement income. Truth be told - not much. That is why I didn't blog it in real time.

 

Not much has changed since last year's conference, although the conference itself was both better organized and better attended. Kudos to the conference co-chairs - Francois Gadenne of Retirement Engineering, Inc. and Charlie Ruffel of PlanSponsor for that.

 

I did, however, walk away with a couple of themes that seemed to run throughout the conference. Before I summarize them for you, I would warn you that the themes I walked away with are the product of my own very real biases and filters. It is not only possible but highly likely that the other attendees walked away with an entirely different set of themes. But you are reading my blog, so here they are:

 

The problem is real. Believe it or not, there is still some debate about this. But at the end of the day, it is plainly obvious that the retirement income problem is very real and very pressing. As to what is being done about it, I think the news is mixed. Clearly, the attendees to this conference are very aware of the problem, if for no other reason than that it represents a big, fat, hairy opportunity for those who address it - or a big, fat, hairy threat to those who ignore it.

 

My sense is that the big industry players cannot let go of the idea yet that they can solve the problem with existing products. There is still a overwhelming desire to cram a square peg (modern portfolio theory, mutual funds, annuities, et. al.) into a round hole (a very new and real problem). Yes, they may add a few bells and whistles to them but you can't put a suit on a pig and pass it off as a prince!

 

People wait until it is too late. Another flash of the blindingly obvious. You can posit many thoeries on why but the fact is that people in general wait until far too late to address retirement issues. They wait far too late to begin accumulating assets in retirement and then are forced to take on far more risk than is appropriate for money you absolutely know you are going to have to have someday. They wait until it is far too late to begin understanding the issues and risks that need to be addressed to successfully negotiate 30 years of retirement. And finally, they wait until they are far too late to switch from accumulation to income.

 

One of my biggest Aha! Moments came when Professor Zvi Bodie, from Boston University, mentioned that the academic evidence completely contradicted the conventional wisdom in the area of asset allocation theory. According to Dr. Bodie, this research indicates that rather than taking more risk when you are younger and less when you are older, a person is best served by a constant level of risk over their investment horizon.

 

This would be totally consistent with my view and my way of investing, not to mention my own experience. I will post more on this idea later. For now though, it supports two points I harp on all the time: 1) manage risk and the performance will take care of itself; and 2) income investing isn't for old people. The time to switch your portfolio to an income stream is early, way before you need income, in order to avoid the conversion risk. After all, income re-invested is growth.

 

There is a huge disconnect between retirement expectations and the retirement reality. The data suggests that we are largely still in a state of total denial! Proof of this fact lies in five major areas.

 

First, the replacement rate is steadily shrinking. Replacement rate is the amount of pre-retirement income that will be replaced by government entitlements (like Social Security and Medicare) and employer sponsored pensions. The federal government is mired down in finger pointing and politics as usual and with each passing day gets farther and farther away from fixing the Social Security and Medicare problems.

 

Meantime, the percentage of workers who are participating in pension plans is shrinking every day. According to the Bureau of Labor Statistics, the percentage of full-time workers covered by a defined benefit plan has gone from 42% in 1990 to 18% in 2005. Given the almost daily news of major corporations like IBM, Verizon and Gerneral Motors freezing or terminating plans, that trend is likely to increase or even speed up. And yet, the worker is in my view, very slow to recognize the implications or make course corrections. You have an entire generation, that being the baby boomers who are standing there like deer in the head lights!

 

If you ask baby boomers how they intend to deal with their savings shortfall, 66% say they plan to work past age 65. In reality though, only 26% of them actually do and EBRI studies say that a majority of recent retirees were forced to retire earlier than they wanted to by job or health issues. If this is plan A for 66% of 76 people, I would suggest we need to find a plan B and find it fast!

 

I heard at least one person argue (John Ameriks from Morningstar) that the problem wasn't as dire as all of us worry worts are making it out to be. I think it is worse. One reason I think so is the spiraling cost of healthcare. This was my other Aha! We know that few people have even done a thorough analysis of their income needs in retirement by the time they retire! I would bet that even those that have underestimated the cost of healthcare over their lifetime. In his talk, Jerry Kinney, Vice Chairman of Merrill Lynch reminded us that healthcare costs are increasing at 10X the rate of the CPI!

 

For someone turning 65 in 2006, it is estimated that, on average, 37% of their Social Security benefit will go to Medicare premiums, co-payments and out-of-pocket expenses. By 2026, that number is expected to be 53%. Combine that with the fact that Social Security benefits make up over 80% of the income for more than half of the over 65 population and that leaves little or nothing for even the most essential items like food, clothing and shelter.

 

Here is another example. The person who turns 65 in 2015 and lives to be 90 (which is a much higher probability than most people think) will spend an estimated $426,000 in cumulative healthcare premiums, co-payments and out-of-pockets expenses. That is huge by any measure, but especially scary when you consider that the average retiree doesn't have anywhere near that much saved, in total, at retirement. It's pretty hard to see that scenario playing out in a positive fashion.

 

Earl Wilson says we are a generation "driving mortgaged cars on bond financed roads using credit card gas." Strange but true, baby boomers will enter retirement with more debt than assets. According to FRC, the average American is now in a net negative financial situation.

 

Given that, it isn't surprising that Americans do not have enough saved to maintain their current standard of living. The average 401(k) balance for those in their 50s as of December 1999, in other words, the near retiree group, was only $129,218! According to the Employee Benefit Research Institute, 60% of baby boomer sill have to make hard choices about reducing their standard of living in order to keep from running out of money and another 20% will, barring some unforeseen miracle, run out of money before they run out of breath!

 

Call me Chicken Little but I really do believe the sly is falling. I am eagerly looking forward to the day that someone shows me overwhelming evidence to the contrary but until then I feel we must continue to ring the church bells and shout from the rooftops, "Retirement is coming! Retirement is coming!"

 

I am always very interested inhearing your thoughts and feedback. Please post your coments below.

 

SOURCES:

 

Too numerous to list here. General attributions were given throughout. If you need a source for any of these numbers I will be happy to provide them. Just email me.

Up, Down or Sideways?

Warning: This post deviates from my standard policy of not discussing the Snider Investment Method on this blog. But, in this context, I hope the information will be educational rather "salesy". At least - that is the way it is intended. So here goes ...

 

Have you noticed how many commercials on the radio lately are talking about making money whether the market goes "up, down or sideways"? I have been using that phrase for a long time to describe the Snider Method - long before it became so fashionable apparently. But is everyone talking about the same thing?

 

The answer is an emphatic NO.

 

There are three possible interpretations of the phrase "makes money whether the market goes up, down or sideways". Let me take you through each, talk about who uses them and what they really mean.

 

Insurance Salesmen

 

This phrase is often used in connection with a principal protected annuity product. It will sound something like this … "You get stock market returns or x%, whichever is higher, so you can't lose. You make money whether the market is going up, down or sideways!"

 

There is no point in my rehashing all the problems with deferred annuities in this post when I have already covered them so extensively elsewhere on this blog. If you are interested just click the link for the category "Variable Annuities".

 

Speculators

 

The way the phrase is used most often is the way people think we (read: I) mean it - but don't. The majority of investments (and investment seminars or strategies) are speculative in nature. They depend on correctly guessing which way the price of the underlying asset will move and then placing a bet on the accuracy of that guess.

 

This category would include owning stocks, selling stocks short, mutual funds, long-short funds, and buying or selling options, commodities or currencies (either in combinations with one another or as a straight bet). The most common usage of the phrase "up, down or sideways", in this context, comes from people who sell trading seminars or software.

 

One example would be WizeTrade or 4X Made Easy. These two software platforms work on the same premise. Their software lights up with red and green lights to tell you when you should buy or sell the underlying security. The theory is that is the software tells you something is going up, you buy it. When it thinks it is going down you sell it - or even sell it short which is a bet on the security going down in price rather than up.

 

Another example would be a covered call seminar like Compound Stock Earnings or the now defunct Wade Cook. In order to make money with a traditional covered call strategy you must be able to find stocks that are consistently going up - preferably, not too fast - even in bear markets. If they rise slowly, the covered call will be more profitable. If it rises too far, too fast, the covered call will have left money on the table and you would have been better off in a straight bet on up - either by owning it outright or by buying the call option.

 

Other examples in this vein would be Optionetics, Trade Secrets, Options Made Easy, Optioneer and others that are primarily options based. If I know that a stock is going to rise, or even better, how much and over what time frame, there is an option strategy I can use to make money from that. If I know that a stock is going to remain range-bound for some period of time there is a different option strategy that will make me money from that. And if I know a stock is going to go down, there are yet more strategies I can use to make money from that. But, there is no one options strategy that can make money under all three scenarios.

 

So when these folks talk about making money whether the market goes "up, down, or sideways" there is a HUGE unspoken assumption underlying it which says "provided you have a crystal ball" and none of us do! If they tell you their system or software is that smart, they are lying, you should put on your track shoes and run like hell! Market timing or stock picking are a fool's game that you cannot win.

 

The Snider Investment Method

 

When I say "up, down or sideways" I am saying two things different from what you just read above:

 

1.) I am saying that the Snider Method makes no attempt to time the market or pick stocks that will move in a given direction because we don't care - we are not trying to bet on direction, and

 

2.) We use the exact same methodology in every case, regardless of what the underlying asset does so we can accurately say "make money regardless of market conditions".

 

No trading seminar or software peddler can say that.

 

I think the main point is this, with investments - as in all things - people often say the same thing but mean something different. It is up to you to understand what they are REALLY saying, or SHOULD BE saying, and base your decisions on that. Don't fall for slick rhetoric without understanding what lies underneath. (Pun intended!)

 

Thoughts? Comments? As Always - please leave them below. Thanks for stopping by.

Selling Equity Indexed Annuities to a 94 Year Old!

At the Regulatory Affairs and Compliance Conference, sponsored by the National Association for Variable Annuities of Reston, Va., the NASD announced that it will be releasing a regulatory notice to members on the subject of equity indexed annuities.

According to a widely circulated draft copy, the SEC worries that "the absence of firm supervision of the marketing and sale of unregister EIAs" (Equity Indexed Annuities) by broker dealers could create problems.

From the article in financial-planning.com:

Selman described a recent complaint involving a 94-year-old woman and her 91-year-old husband. An insurance agent recommended that the pair liquidate $800,000 in fixed income savings, the bulk of their assets, in order to buy an EIA with a 14-year surrender charge. Selman said that another remarkable aspect of the case was that the complaint was filed by the registered representative who was managing the fixed income portfolio, not the customers.

That guy should not only lose his license and be barred from the industry but he should also be shot!

Annuities: Committing Annuicide

When I was speaking last Saturday at Rich Dad’s Investor Workshop I mentioned that I am opposed to picking stocks, buying mutual funds and annuities. An adviser came up to me during the show and questioned me on why I didn't like annuities. Just yesterday, I received an e-mail from one of my students asking the same question.

 

I spoke with you after the session when I attended April 2004. I mentioned I was just beginning to sell life insurance after being laid off from telecom.

 

Recently I have become quite enamored with the Amerimark Equity Indexed Annuity. In your newsletter today, you referred people’s safe money to ING’s money market at 2%. I also have a friend who said you are opposed to all annuities. Is this true?

 

My first observation is that everyone who sells annuities seems to be enamored with them. Imagine that! They pay a 6% commission. My question is why are the only people enamored with them the people who sell them?

 

But hang on a minute. I'm getting ahead of myself. Harold Evensky says the word annuity is like the word cancer. It is so broad and so widely used but can mean so many very different things. Let's just be clear what we are talking about.

 

We can broadly divide annuities up into two categories: immediate and deferred. The category I have such a problem with are the deferred annuities. Immediate or fixed annuities may very well have a place in a retirement portfolio to guarantee a minimum income level, especially for the person who is retiring on a very small amount of money.

 

But deferred annuities are a different deal altogether. And yes, it's true. While I would “never say never”, the percentage of people that a variable or equity indexed annuity are appropriate for is absolutely minuscule and yet the problem I have is they are being sold left and right to everyone. I think that's egregious.

 

I have written numerous articles and spoken to this topic on the radio show countless times. I've also done interviews with other experts on the subject. You can find all of them in the variable annuity category to the left.

 

But to summarize, here are my beefs with deferred annuities, whether of the variable or equity indexed variety:

 

• Expenses and commissions are too high thereby creating a conflict of interest for both the broker selling them and the insurance company managing them.
• They are tax disadvantaged in about three very meaningful ways in spite of the fact that they are sold as being tax advantaged. For more on this, see a very good recent article by Scott  Burns.
• The performance sucks and the subaccounts are mutual funds. Enough said.
• You can't get your money without penalty for anywhere from seven to 10 years.
• The sales practices are abusive. Generally, the only person the deferred annuity is appropriate for is someone who is very young, has a long enough time horizon to actually get some benefit from the structure, has a very high income level and is maxing out all other tax-deferred accounts. Yet, these are sold day in and day out to the very opposite sort of person - mostly to older people near, or very near to retirement. That's just wrong.
• Many of these deferred annuities are being put inside IRAs. That's also just wrong. A tax-deferred account inside a tax-deferred account makes no sense except to the person receiving the 6% commission.

 

To summarize, for 99.99% of people, I think buying a variable or equity indexed annuity is basically committing “anuicide.” Many don't agree with me. Many do.

 

The subject of annuities is one of intense debate. Executives from almost all of the large insurance companies were in attendance at the Managing Retirement Income Conference I recently attended in Boston. On at least five different occasions, one of them posed the question the group, "Why are people so against annuities?" I'm sure they didn't like the answers.

 

Every article I write or radio show I do on this topic elicits heated responses on both sides of the issue. That's good! That's what blogging is all about - to encourage constructive airing of ideas so that everyone can make up their own minds. So in that spirit, feel free to leave your comments below. Please note however that any pitches for a specific product will be removed!

Variable Annuities Rarely Benefit the Investor

Dennis Houlihan, president of Houlihan Asset Management, LLC talks about the uses and abuses of annuities in another good article from NAPFA's (National Association of Personal Financial Advisors) May 2005 newsletter.

 

Sales of annuities, unfortunately, are driven by high sales commissions. They are inappropriate for IRA or 401(k) accounts because those accounts already are tax-deferred. There is no benefit to putting tax deferred investments into a tax-deferred annuity. Emphasis his - not mine.)

 

Therefore, if you have maximized all of your IRA and other tax-deferred retirement contributions, it might be worth speaking with your financial advisor about an annuity. But even in those circumstances, you need to look carefully at the marginal tax rate you face and the expenses of the annuity you are interested in purchasing.

 

Fixed annuities may make sense if you wish to generate steady monthly income and are concerned about preservation of principal. Variable annuities, on the other hand, rarely benefit the investor because they have high expenses and mediocre investment fund performance.

 

For a full discussion of why this practice of putting variable annuities inside IRAs borders on malpractice, listen to my interview with Gary Schatsky, chairman emeritus of the National Association of Personal Financial Advisors.

Variable Annuities In IRAs

According to a study released by the Investment Company Institute, 20% of IRA account holders have a variable annuity inside their IRA. Another 20% are holding fixed annuities.

 

For a full discussion of why this practice of putting variable annuities inside IRAs borders on malpractice, listen to my interview with Gary Schatsky, chairman emeritus of the National Association of Personal Financial Advisors.

 

 

SOURCES:

 

1. Sarah Holden, Kathy Ireland, et. al. "The Individual Retirement Account At Age 30: A Retrospective."Perspectives http://www.ici.org/pdf/per11-01.pdf Feb 2005.

 

2. Gary Schatsky, interviewed by author 01 Nov 2004, telephone interview, Dallas, TX.

Who Are The Advocates For Annuities?

Jim Essert says I am a "numbskull" and that I am wrong on Equity Index Annuities.

Jim, do you sell annuities?  (As if I have to ask!)

Why is it that the only advocates for annuities are those selling them? Where are the customers singing their praises if they are so good? Show me a customer evangelist for annuities.

Where are the advocates in the financial press? Show me a financial writer (that doesn't sell them or have a financial self interest) that thinks they are a good deal for the customer.

Why does the Securities Exchange Commission, the National Association of Securities Dealers and the North American Securities Administrators Association consistently list the sale of annuities on their list of scams?

Why are Elliott Spitzer and the SEC investingating companies like Prudential (among others) for the inappropriate sale of annuities?

I am not saying they are never appropriate. There are limited cases where they may be. I am saying  beware - read the fine print - they are consistently oversold.

But I do find it telling that the only people advocating annuities are the people getting rich by selling them.

Equity Index Annuities: Beware

I did a series of talks last week and in one of them, someone asked me about equity indexed annuities. He wanted to know if equity index annuities didn't achieve the same objectives as my cash flow method. Unfortunately, being in the Q&A section of a talk like that, I didn't have enough time to talk about all the problems with EIA's.

 

Robert Powell, of MarketWatch outlines the issues very well in an article this week titled, A Ball of Confusion.

 

"Sales are booming because people have been terrified of the volatility in the stock market," says John Olsen, head of the Olsen Financial Group in Kirkwood, Miss.

 

Yet EIAs are among the least understood and most oversold products in America today, Olsen says. And they bear an often overlooked risk -- they're dependent on the financial strength of the insurance company offering them.

 

"A lot of sales are not proper," Olsen says. "A lot of agents sell EIAs as an alternative to stocks or to bonds or CDs and that's not appropriate.

 

"It's a fixed annuity and annuities are not investments. They are risk-management products. They are not alternatives to bonds because they don't act the same. They are horribly complicated."

 

There are some things you need to understand about equity indexed annuities. When you read the fine print, they are not all they are cracked up to be.

 

• The minimum guaranteed rate: That's the rate of interest the insurer guarantees to give you, the contract holder. The minimum rate currently ranges between 1.5 percent and 3 percent, typically on 90 percent of the initial premium deposit. But Shah says many insurers are lowering the base upon which the guarantee applies as a way to improve profitability and reduce some of the risk that comes with selling EIAs in a low-interest-rate world.

• Participation rate: This is the rate at which you, as EIA owner, share in the upside of the equity index being tracked, typically the Standard & Poor's 500, but increasingly other indices as well. Typically, the rate (say 55 percent of the S&P 500 minus the dividend) is set when the EIA is issued and guaranteed for one year. The participation rate will depend on interest rates and the cost of call options.

• Spread deduction: This is the fee charged by insurers for their expenses. Usually, it's deducted from the percentage increase in the equity index being tracked.

• Return cap: This is the maximum rate that can be credited to an EIA owner's account, regardless of the actual market returns. Typically, that cap is set low such that an EIA owner can expect to earn the minimum guaranteed rate, say 2 percent currently, plus another 2 percent when the stock market rises -- 4 percent overall.

• Index-crediting methods: Insurers use various formulas to calculate the equity index's return for your EIA. The most common method is the annual reset-averaging index, but there are others.

 

The gist of it is, that although these things are advertised as getting all the upside potential as the stock market rises, the truth is that you get very little of it. In the end, most of these equity index annuties will end up paying somewhere around 1% - 2% as a guarantee and 4% - 5% when the market is going up.

 

If you want low risk and you are satisfied with those sorts of returns, high grade bonds will achieve the same thing more effectively.

 

SOURCE:

 

1. Robert Powell, "A ball of confusion. Beware equity index annuities promising returns sans risk." CBS Marketwatch.com 10 February 2005 http://cbs.marketwatch.com

What's Wrong With Variable Annuities?

"Variable Annuities are sold more aggressively than fake Gucci handbags on the streets of New York City." ¹

 

My guest on the radio show Saturday was Gary Schatsky, Chairman Emeritus of the National Association of Personal Financial Advisors, or NAPFA. Gary and I discussed at length the reasons variable annuities are terrible investments for 99.9999% of the investing population but such a great deal for the people selling them.

 

This was the second time I aired this interview. Both times I was overwhelmed with people asking where they could get copies or transcripts of the interview. These requests come from three groups of people: 1) Those that already own variable annuities and wish they didn't; 2) Those that are being pushed hard by a salesperson to put their money in one; and 3) Lawyers who have suits pending against the insurance companies related to the sale of these abusive and grossly overpriced products.

 

“Great spirits have always encountered violent opposition from mediocre minds.” 

                                                ~Albert Einstein

It seems there just aren't that many people talking about what a bummer variable annuities are for investors. And those of us who are find ourselves universally cursed by those who sell them. But what would you expect? By educating you on the facts, I am threatening a very lucrative business for them.

 

Well, get out the rotten eggs and rancid tomatoes fellas because I am going to keep shouting about your malfeasance until I have no breath left. It is a travesty. It is a rip off and a mockery of the trust people place in you. They are bad investments. Period.

 

For those of you who emailed me or called asking for a copy of the show, I will do you one better. Use the link below to listen to the interview in its entirety, not just the portions that made it into the show.

 

 

SOURCES:

 

1. SmartMoney Magazine, "What's wrong with variable annuities?"

http://www.smartmoney.com/retirement/investing/index.cfm?story=wrongannuities, 30 Nov 2004

 

2. Gary Schatsky, interviewed by author 01 Nov 2004, telephone interview, Dallas, TX.

NASD continues probe into abusive sales practices of variable annuities

The NASD has said it has resumed its probe into abusive sales practices of variable annuities because those practices haven't stopped since they originally began investigating last year.

The two abuses that seem to be the most common are selling annuities to investors when they are not appropriate investments for that investor and what the NASD calls “inappropriate switching”. This occurs in many instances when an advisor leaves one firm and takes his clients with him.

When brokers go to another firm, they are often paid extra commissions. It's sort of like double coupons, to get them started. Many brokers use that opportunity to switch their clients out of their old annuity, into a new one.

Variable annuities are very lucrative for the person selling them. Bloomberg columnist John Wasik notes, "Variable annuities continue to be sold aggressively because commissions on them are generous -- as much as 10 percent -- versus a 4.5 percent load for a conventional broker-sold mutual fund."

This window where the advisor is paid extra opens the door for greedy advisors to switch, "or churn", their client's annuities for a fat payday. The advisor engaging in this practice usually covers his recommendation to the client, telling the client the annuities at his new company are "better" than those he sold them at the old firm.

It’s probably not a coincidence that this investigation has come up again at the same time Elliott Spitzer has filed suit against a number of the nations’ largest insurance companies, which are the companies that sell these variable annuities. Many observers expect Spitzer’s investigation to spill over into the area of variable annuities as well.

I mentioned there were two common abuses. Wasik says, "Variable annuities are much like flood insurance for people living on mountaintops. Very rarely are they needed." But they are peddled as aggressively as fake Gucci purses on a New York street corner.

"High commissions, typically above 5 percent for variable annuities, help drive sales of these products,'' concluded a joint SEC/NASD staff report in June, adding ``high fees and surrender charges combine with other factors to make variable insurance products inappropriate for many investors.''

I would amend that last sentence to say MOST investors.

SOURCES:

1. Alistair Barr, "NASD still probing variable annuities," http://cbs.marketwatch.com/news/print_story.asp?print=1&guid=%7B666B29EB-774D-4186-9677-CE88F647503B%7D&siteid=mktw, 21 October 2004.

2. John Wasik, "How to Avoid the Sting of U.S. Variable Annuities," http://quote.bloomberg.com/apps/news?pid=10000039&sid=aYqs8s9ENazc&refer=columnist_wasik, 20 September 2004.