Financial Products Are Sold, Not Bought
Year-to-date, the S&P 500 is 7.78 percent lower. From the high it set in May, the S&P 500 is down over 11 percent. Outside of a few companies within the index (Facebook, Amazon, Netflix, Google - now Alphabet), the index is even worse. Over half of the companies in the S&P 500 are down by 20 percent.
Although investors inherently know stocks and bonds returns are not always positive, humans are loss averse. For example, according to Daniel Kahneman’s Thinking Fast and Slow, individuals fear losing $100 more intensely than they hope to gain $150. Unfortunately, whereas MFG’s approach is to educate and discuss these issues, many advisors use fear as a selling technique, especially in volatile times like these. When fear enters the market and investors fear losing money, financial vultures circle unsophisticated investors, offering products and ‘solutions’ to their fearful problems.
Preface: variable annuities can be valuable to an individual’s financial plan. However, they are often sold as investment vehicles to individuals without the consideration of their overall need.
“If you invest in this annuity, you will never lose money. There is a floor on your account value and you will never lose your principal.”
Each annuity, at each insurance company is different. But, generally, they offer downside protection and cap the upside potential. In order to promise these returns, insurance companies assume risk and transfer it’s cost to the insured.
The SEC provides information about variable annuities. Here are the costs:
- Surrender charges: for the first few years of the contract, there is a penalty to withdraw the money. Typically the first year is six percent and decreases by one percent per year.
- Mortality and expense risk charge: 1.25 percent per year to cover insurance company’s risk, which it assumes under the contract.
- Administrative fees: 0.15 percent per year to cover record-keeping and other administrative expenses.
- Mutual fund fees: 0.70 percent (icifactbook.org) is the average mutual fund fee in 2014. Assets in the variable annuity are often invested in mutual funds.
- Lastly, insured often have the option to add a ‘rider.' For this example we will use Jackson National’s five percent Guaranteed Minimum Withdrawal Benefit with Annual Step-up. The cost of this income rider is 0.85 percent.
- Thus, the underlying costs of the annuity can be around three percent.
Despite the charges in annuity contracts, brokers often seek opportunities to sell them because they often pay commissions around six percent on the amount added to the contract.
The takeaway from all of this is that unfortunately, when investors are at their most vulnerable, products such as annuities are sold as the solution rather than education. Our advice is simple: when in doubt have a fiduciary review any financial products being proposed as appropriate for you and your finances. This will provide a second opinion from a qualified advisor who is obligated to put your interests first. Lastly, be certain to understand all fees and compensation paid to broker, as this is often an incentive to sell what is deemed suitable given your fears to losses.