With all the investments out there such as mutual funds, exchange traded funds, hedge funds, stocks, bonds, etc., why then the huge attraction to variable annuities? You cant pick up a newspaper, turn on the television, listen to the radio, or have a conversation about investments without the subject of variable annuities (VAs) coming up. So, whats all the buzz about? Well, ironically, all of the hype thats pushed to the forefront is almost always negative. Nevertheless, the latest estimates are that close to one trillion dollars are invested in VAs. What does a statistic like that signal to investors? It tells you that something good must be happening, right? Why would so much money be invested in variable annuities if people werent benefiting in one way or another?
Well, heres the inside scoop: Although several variable annuities are great additions to many investment portfolios, certain ones at times can be detrimental to the overall health of any portfolio. This can be due to potential lengthy lock-up periods, high expense ratios, and possible conflicts of interest that can arise because of the often high commissions paid by the investor. As you know, anytime large commissions are involved in sales, misrepresentation, lack of disclosure, and other types of foul play can be involved as well. Some of the people that are selling VAs see it as an opportunity to make a fast buck.
Unfortunately, in the process, trusting investors not well versed in this area of expertise can find themselves on the short end of the stick. When this happens, the real tragedy is the major group affected by it; thats typically seniors 50-80 years old who are gearing up for, or are already in, retirement. Both groups are almost always in a position where money saved up can rarely be recovered by the remaining years of work or through returning to the work force and starting over again. And remember, in a lot of cases, its their lifelong savings were talking about! This is another classic example of the One bad apple theory: A few brokers/agents illegally putting their own selfish interests first, ahead of the well being of their clients. And unfortunately, this has rung true, and has been a rapidly growing phenomenon.
Heres the good news: A lot of these potentially abusive policies have been sold outside of New York State, where the insurance laws are more lenient. The way this works is each state usually has its own rules and regulations governing the insurance industry. New York State is one of the most highly regulated and toughest states in the country to do business in for the insurance companies. For an insurance company to do business here, they must agree to participate in the New York state insurance pool. This pool helps insulate investors from the risk of losing their money in the event their insurance company should go bankrupt. Well, that protects you if the insurance company screws up, but that doesnt seem to be where the problem lies today. What we see as the major problem is this: How can investors today protect themselves from getting ripped off or ill advised from one of these bad apple annuity salespeople?
First, it probably makes sense for us to give you a little background on what a variable annuity is. A variable annuity contract allows you to allocate your premium among a number of investment portfolios, consisting of any mixture of stocks, fixed income instruments or money market accounts. Your contract value will reflect the performance of the underlying investments held in those portfolios, minus the contract expenses, and is subject to market risk, including the potential loss of the principal invested. A variable annuity is a personal retirement account that brings together the best features of managed investments and insurance. Your money accumulates tax-deferred in professionally managed funds until withdrawn. And, you can feel safer knowing your beneficiaries will receive benefits upon death. In addition, guaranteed income and principal protection can be purchased within the contract. After everything our country has been through over the last few years, many investors are willing to pay for these guarantees. Because of the potential to have tax-deferred growth with guarantees in place, more and more people are looking to variable annuities as a panacea to stock market uncertainty. Heres a case that just recently crossed our path.
When Mr. and Mrs. Jones came into our office inquiring about variable annuities a few weeks ago, with all the buzz previously discussed, we expected them to be more thoroughly versed on the topic. During our consultation, we found out very quickly that they were not. They had violated one of the cardinal rules of investing. Mr. and Mrs. Jones had not educated themselves on the topic of variable annuities. They actually said the reason theyre interested in variable annuities is because their friends have them and continuously rant and rave about how good they are. We see it in our business often; investment decisions, regardless if correct or incorrect, being made for the wrong reasons. It ends up that the Jones are a great example of a situation where we feel that a variable annuity would be a fitting investment that would assist them in meeting their needs and financial goals.
Heres why: Mr. and Mrs. Jones are both 68 years old and have been married for 39 years. Theyve both just recently retired, and are currently receiving monthly social security and pension payments. Between the two of them, their monthly intake is $4,500. Their regular expenses average at $5,000, with an additional $500-$1,000 spent for miscellaneous reasons. Because of the $1,000-$1,500 monthly shortfall that usually exists, their main need is to supplement the payments they receive with an additional income. This supplement would be essential in helping them to meet their necessary expenses and have some money left over for travel, entertainment and lifes unpredictable expenses that seem to have a habit of always coming up. They were interested in choosing an investment path that would give their money a chance to grow rather aggressively, tax-deferred, while minimizing downside risk and maintaining principal protection, while concurrently serving as a reliable income source (a case not unfamiliar to us). Because of the needs, risk tolerances, and financial and personal situation of Mr. and Mrs. Jones, the variable annuity not only was a good fit, but the best we could figure.
When shopping for annuities, or any type of investment for that matter, the first thing we recommend doing is to make a list of your needs, goals, time frame, and desired investment amount. That is the first thing we did with Mr. and Mrs. Jones when they walked into our office. Even before discussing annuity types and insurance company ratings, you need to have a plan with goals clearly laid out. We usually create a grid for comparative purposes where each category can get a checkmark and weighting so that priorities can be determined. Some important categories to analyze when dealing with variable annuities are expense ratios, lock-up period lengths, annual withdrawal limits, penalties, surrender charges, and age constraints for certain benefits within the annuity. Benefits often discussed are guaranteed income options, up front bonus options, stepped-up death benefits, etc. That is why it is important to take the approach that allows one to visually understand and weigh what you are getting for the amount youre paying.
There are many reasons why investors, like Mr. and Mrs. Jones, may choose to go with a variable annuity rather than more typical types of safe investments, such as bonds. Although bonds can serve as a stable source of fixed income under many circumstances, the returns are often not enough for many. With the 10-year Treasury bond currently yielding a return of 3.9%, versus the 6.5% the S & P 500 is yielding, its no wonder more people are turning to more aggressive options that strive to take advantage of upswings in the market, while providing some type of protection on the downside. That is when the variable annuity becomes an option you may want to explore. But with more VAs to choose from than there are pain relievers on a drugstore shelf, how can you choose the annuity that is most appropriate for you, if it is appropriate at all in the first place?
Well, the answer lies in education. Weve found out over time that there is no single best way for one to educate himself/herself. Whether its reading a book about VAs at a local bookstore on a Saturday afternoon, attending a two-day seminar, listening to a set of audio tapes in the car during your drive in to work, or enlisting the help of a trusted advisor; any of the above methods, in addition to many others, can be extremely helpful in getting familiarized with the wide array of investment vehicles available to you. In this case, the clich knowledge is power proves to be very true. Its the difference between developing a general understanding of what are fitting investments that will help you reach your financial goals, or just getting lost in the mix. This idea has been proven to us over and over again.
When the client is informed and has all of his or her questions answered, not only does their satisfaction increase, but also their comfort level with the decisions that are made. Some investors might feel a little intimidated by this process, but thats ok and perfectly natural. There are literally thousands of different routes one can take when investing, and its not always easy to know which one is in your best interest, but that is why a trusted advisor is there. After youve gained a feel for what is available out there and what youre looking for, then its often wise to consult with a trusted advisor in order to have a professional opinion that is keeping your best interests in mind.
In the end, a good indicator of how qualified the annuity specialist youre dealing with is would be your gut feeling. This should be the final deciding factor, and arguably the most important. If Mr. and Mrs. Jones can look this person in the eye and feel as though he or she is keeping their best interests in mind, theyll most likely feel good about the idea of working with this person. If everything else mentioned above checks out ok, chances are the Jones will be comfortable with the decision they come to make. This in turn usually leads to a feeling of strong gratification when the expected outcome of your investment decision becomes a reality.
Don Conrad is president of Conrad Capital Management, an independent registered investment advisor, in Melville, New York. Can be reached by phone: (631) 439-7878 or email: don@conradcapital.com
Don started his career in the late 1970s at a nationally recognized mutual fund company and was recruited after three years by E.F. Hutton Company to work in the consumer retail division. During his thirteen-year tenure there, he spent two years specializing in and trading the 30-year treasury bond. For the last five years, he served as a senior vice president focusing his efforts in the Consulting Services division, maintaining offices in both Long Island and Manhattan.
In 1993, he was recruited by PaineWebber as a Senior Vice President in the consumer retail division. In addition to managing his clients assets, he was asked by senior management to conduct a nationwide tour to train financial consultants in the Consulting Services division. Don also made a video on the use of advanced technology in the financial services industry. This video was distributed to PaineWebber offices internationally.
After almost five years at PaineWebber, Don decided to pursue his dream by starting Conrad Capital Management in order to offer his clients more choices and flexibility.