Tuesday, April 05, 2005
Okay---Let's Get Real
A sure thing? Better to avoid those equity index annuities
March 20, 2005
How would you like to invest in a sure thing?
If you sink your money into this amazing investment, you can kick back and enjoy nearly all of the glorious gains of the stock market for many years to come. But, here's the really unbelievable part. When the stock market does its occasional imitation of a 20-car pileup, you'll walk away without a scratch. That's right. You won't lose any money.
Does it get any better than that? Not if you listen to the insurance agents and other commissioned salesmen who hype something called the equity index annuity. After listening to its boosters, you'd swear this annuity will be a shoo-in for canonization because it appears to be the answer to every skittish investor's prayers.
But folks, if you are hoping this is a miracle investment, it isn't. This annuity, however, is a godsend for the eager agents, brokers and commissioned planners who peddle them. The enthusiastic sale force is rewarded with huge commissions and they get to lob a big fat sales pitch down the middle of their potential customers' living rooms.
Who, after all, wouldn't want to earn generous stock market returns without risking any cash? This pitch especially appeals to investors who remain intimidated by the stock market's volatility, but who naively believe there is a way to strike it rich without putting at least a finger or two on the chopping block.
When you look closely at EIAs – and most people don't bother – the blemishes are clearly visible.
There is plenty to dislike about equity index annuities, beginning with the name, which is a true marketing coup. Despite what the name and the glossy handouts suggest, these annuities aren't risk-free stock investments; they are just dressed-up fixed annuities.
Like a certificate of deposit, a fixed annuity offers a modest return on an ultraconservative product. The equity index annuity differs from a traditional fixed annuity because of the way interest is credited to its value. The interest for the typical fixed annuity is determined by the rate dictated in the contract. The EIA credits interest with a complicated formula that is based on changes to whatever index, such as the Standard & Poor's 500 index, it is linked to.
If you examine the EIA's potential for impressive stock market returns, it's arguably as flimsy as a Hollywood stage set. For starters, an annuity's upside potential is limited. The contract's participation rate dictates what percentage of market gain is credited to an account.
You might, for example, earn 70 percent of any gain in the S&P 500 or the Dow Jones industrial average. But that figure is misleading because the percentage isn't tied to an index's entire gain. In this example, the calculation would be based on 70 percent of the index's return, minus the performance generated by dividends.
Historically, about 4 percentage points of the Standard & Poor's return of 10.4 percent can be traced to dividends. So when you disregard dividends, you kiss a lot of an annuity's return goodbye.
There is also a cap on the gain you may be anticipating when the market starts racing like a Triple Crown winner. Many other factors also determine how each one of these annuities is credited. In the industry, there are dozens of different crediting methods.
Now let's look at the downside protection. One of the attractive selling points of these annuities is that no matter what is happening on Wall Street, customers are guaranteed a certain base annual return over the life of the contract.
It could be 2 percent or 3 percent. But what many people don't understand is that this return is often not based on what you sink into an EIA. It can be based on a portion of it. If you invest $100,000, you may only get the guarantee on, say, $85,000.
One of the biggest deal breakers with these annuities is the commission. Agents are rewarded with commissions that can hover in the 10 percent to 15 percent range. Onerous surrender charges are another turnoff. In extreme cases, if you want to bail from one of these annuities, the insurance company will confiscate 20 percent of your money before releasing what's left.
So what is your reward for this expensive peace of mind?
Glenn Daily, one of the nation's foremost fee-only insurance consultants, suggests that during bad years on Wall Street, EIA investors would be better off owning a plain old fixed annuity or certificate of deposit.
During periods when the markets are smoking hot, investing in stock mutual funds would be a smarter option. Let me translate that for EIA customers: Heads you lose. Tails you lose.
Luckily, there are plenty of alternatives for EIAs, which all investors managed to live without before they were introduced in 1995.
If you absolutely can't afford to lose money, you can stick your money in a certificate of deposit, a fixed annuity or a money market. You could also diversify your risk with a conservative asset mix. You could, for instance, place 80 percent of your money in bond index funds and 20 percent in stock index funds.
If you've soured on your equity index annuity (say in the time it took to read this far into the column), you are inevitably going to wonder what you should do. Fleeing is always an alternative, but you may pay dearly in surrender charges. You'll want to find out what your charges would be since they decline the longer you hold the annuity.
Another option is to pay someone to analyze the contract, but there aren't many professionals who can even crack the code. When the state of California, for instance, was developing 403bCompare.com, a Web site for teachers to analyze annuity and mutual fund choices in their 403(b) retirement plans, the developers struggled with the tortuous EIA provisions.
"I was working with some very bright people and their minds were spinning," recalls Scott Dauenhauer, a fee-only financial planner in Laguna Hills who was a consultant on the project.
Because of the complicated return formulas, Daily said, it could even take him several hours to thoroughly understand just one contract.
You may want to think long and hard about asking an insurance agent, or someone else who lives off commissions, for advice on your next move. An agent may advise you to bail from that big, bad old annuity and transfer the money into one that's infinitely better. Yeah, right.
If you own an equity index annuity, consider it a valuable learning experience. And vow that you will never invest in anything again that you don't understand.
Lynn O'Shaughnessy is the author of "The Retirement Bible" and "The Investing Bible." She can be reached at LynnOShaughnessy@cox.net.
End of Article---Now for My Comments...
Now, I have something to say about this ridiculous article. First of all, it is clear to me that this person DOES NOT UNDERSTAND what an equity indexed annuity is or how it works.
Now, I am not sticking up for EIA's (equity indexed annuities) but I am sticking up for knowing what the heck you are talking about.
Equity indexed annuities are complex and there are agents who are doing a terrible job selling them...furthermore, they are not for everyone nor are they the answer to every investor's dream. And if someone is selling it like that, well then shame on them.
However, if you understand them, you can use them to augment your portfolio wisely. Here's the deal...while they don't provide the same returns during the bad time as a fixed annuity can, and they don't provide the same upside as a mutual fund can, they can do something totally different.
They are designed to give someone the "opportunity" to earn more than traditional fixed annuities in the good years and not take losses in the down years. The fact that this article states that investors would be better off owning pure fixed in the down years and mutual fund s in the up years is ABSURD. When was the last time you knew how the market was going to perform???
Sorry, thanks for playing. WHEN INVESTED IN PROPERLY, the EIA can help give more enhanced returns in the good years relative to fixed annuities, and avoid losses in the down years relative to mutual funds---That is not a recommendation but an invitation to look at these vehicles from an UNBIASED standpoint.
I am truly sorry but I am very disappointed by this article. IT is written by someone who didn't do their homework. Again, there are many EIA's that can limit investor's gains, but there are some that can enhance an investor's gains also. Yes, they are certainly not the "answer to all investment problems" but nothing is. As I always state, do your homework and invest wisely. IF anyone states that a vehicle can answer all of an investor's problems, that is a lie. But for someone to poke at a vehicle that has particular advantages without knowing the facts, that is truly ignorant.
Equity indexed annuities CAN be a good thing if used properly. Ask an mutual fund investor who lost 20% if they would have traded an equity indexed annuity that had minimal gains for that year and they would undoubtedly say yes. Ask a fixed annuity investor who only earned 4% if they would trade for an EIA that earned 8% that same year and you might get the same response.
Sorry Lynn, but I think you missed some key points for this article. While I think you were right by stating to not invest in a vehicle you don't understand, I think it is ignorant to say that the EIA in whole is a bad vehicle...but it's okay, maybe you were just in a hurry and didn't do your homework!!!
Ignorance is Not Bliss!!!
Annuities: The Shocking Truths Revealed