Given the wild swings in the stock market over the past three ten years, it’s understandable that investors would be open to just about anything with a guarantee. In 2008 alone, the S&P 500 index dropped by more than 50%. Although it is unlikely you had all of your investments in the market, you were still down substantially in 2008.
Of course, had you stuck it out, you were rewarded in 2009 through early 2010 with a strong rally that gained back much of what was lost in the previous year.
But even if you did stick it out, your investing nerves may have been shot.
If you are considering making a change with your investment strategy, take a moment and consider your options.
Stocks – Whether you have some, most, or all of your investments in a diversified stock portfolio, you can probably expect continued volatility. Economies are rebounding, but slowly, and many developed nations have high national debt levels. Although stock returns have averaged the most in past decades, the future isn’t a given.
CD’s – At the other extreme are guaranteed investments such as CD’s or Treasuries from the U.S. Government. Both are very basic, and easy to understand products. With a CD, you deposit your money at an FDIC insured bank for a set amount of time. In return, you receive interest and your money back. Treasuries are similar, but instead of depositing funds, you loan them to the government for a set period of time (3 months to 30 years) with the promise of a fixed rate of interest, and your money back.
Both are simple to understand, and offer a guarantee second to none.
Unfortunately, they both currently pay very little interest.
If you have thought about this set of circumstances recently, you’re not alone. What you decide to do, however, can play a critical role in your financial future.
Over the past few years, I have been asked a similar question by several clients. It usually comes in one of two formats.
- In the first, a client will have been talking with a friend or family member and “their guy” set them up with a guaranteed 8% return for the next ten years. “Do you have that here?”
- In the second, a client will have stopped at their bank, and after complaining about the market, or low CD rates, the banker will refer them down the hall to their investment person. Typically, they will offer them a high rate of return that is also guaranteed.
Naturally, this sounds like a fantastic opportunity. 8%! Seriously? Where do I sign up?
No seriously, where?
The problem is, of course, if it sounds too good to be true….
Remember when you learned that lesson as a child? Think about it. If we are living in a time when the market drops by 50%, and then rallies by more than 60%, and truly safe and guaranteed investments are paying 1-2%, how can any company offer a guarantee higher than that.
Typically, the product in question is some form of variable annuity. The catch? With most, your funds are tied up for eight to ten years, and upwards of twenty four to fully realize the contract guarantee. Meanwhile, the rep who sold the policy was paid a six to eight percent commission, and you’re being charged upwards of three percent annually while owning the contract.
You must be asking yourself, how can the company pay an agent six plus percent, and guaranteed me eight, in an environment like this? The answer is many people who buy these contracts surrender them early, incurring large penalties (as high as eight percent in the first few years).
The real catch is in the details. There hasn’t been a policy I’ve read where you can invest $100,000, wait ten years, and then take out roughly $222,000 in one lump sum.
Like I said though, if there was, I’d sign up for it!
The reality is, you typically have to maintain the contract for another fourteen years to receive your funds back.
That’s right.
TWENTY-FOUR YEARS to receive your “guaranteed” eight percent return on investment.
My friend Russ Thornton owns an advisory firm in Atlanta, Georgia. A firm he has partnered with did a study of what your actual average return would be over this 24 year period, and not surprisingly, found that your actual return was in the neighborhood of 1.84%. In addition, in testing historical returns, in no time period did buying the annuity work out in your favor. NONE. You can read the full report here.
1.84%
I don’t know about you, but if I”m going to tie up my funds for 24 years (or more), have an agent make 6-8% commission from the sale, and pay north of 3% a year in fees, I expect a little more than that.
So the next time your friend tells you about “their guy”, or the nice person at the bank offers to do you a favor and get you a surprisingly high return with no risk, just remember what you learned in third grade.
Say it with me; if it sounds too good to be true, it is.
photo by Nancy Gluck
