Quote of the Day – Annuities

I would like to get into the habit of posting a quote of the day every day but for now I’ll post them when I come across them.

Today’s (rather long) quote comes to us from the pages of The Ultimate Financial Plan: Balancing Your Money and Life* by Tim Maurer and Jim Stovall in the chapter on annuities:

In the realm of personal finance, no word has been dragged through the mud more times than the A-word—Annuities. Yet annuities survive and even thrive. How they do is not a mystery.

There is not an outcry on the part of consumers demanding annuity products. The reason for the continued vibrancy of annuity sales is that they pay a big honkin’ commission to the selling broker or agent. And, as most of the financial sales tactics exposed in this book, I’m especially qualified to make such a statement, because I have sold them myself. I wasn’t a bad person in those days, conniving to separate people from their hard-earned money for my own selfish benefit. Conversely, every time in years past when I sold an investment product to a client for a commission, I did so thinking it was in their best interest. My recommendations met all the legal requirements of suitability required of a broker, but I acknowledge to you now that in hindsight there is no question my judgment was partly influenced by the amount of money I could make (or not make) on the sale.

And how could it not be? Let’s say you, as a salesperson, had three different products to sell with the following characteristics: one would pay you one percent for every year that the investment continued to be held by the client, one would pay you 5.75 percent up front followed by .25 percent each additional year, and another would pay you 12 percent—all up front. Which one would you be likely to pick, all things being considered equal?…

He goes on to say that the, “…sale of annuities is justified entirely too often because of the massive commissions going ot the broker or agent selling the product.”

I couldn’t agree more. It’s almost like, “Sell first, justify later.”

My belief is that if high cost annuities (variable and the like) were that great for customers, they would have the same payout as a traditional mutual fund.

*Affiliate Link

PLEASE Make Your High School Kids Watch This Financial Planning Video Series!

I just found this on YouTube this morning and have been working my way through the videos. This is very well done except that it’s hard to hear the questions from the audience. Regardless, if you want to give your kids something that will have a positive impact on their lives, have them watch this series. I have listed them all here to make it easy for you. The financial planner’s name is Marnie Aznar and her firm is Aznar Advisors (UPDATE: Her link doesn’t appear to work at this time).

Personal Finance from Rothman Institute on Vimeo.

My Advice to Those Just Starting Out: Keep Good Records

I spent the entire weekend organizing our files.

I don’t know about you but going through files is like taking a walk down memory lane. There were the documents from our first mortgage (1999), medical files from my wife’s three pregnancies, pay stubbs going all the way back to 1998, 401(k) statements going all the way back to the beginning, receipts for big purchases, kids’ report cards, articles and funny stuff I had collected over the years, and lots of other stuff.

I threw out a bunch of stuff away (or shredded it). I kept the stuff I felt was important and filed it away neatly. Some of the financial stuff I put into a spreadsheet. I wish I had done the spreadsheet thing 10 years ago. I think it would have motivated me to better manage our money. I’ve done better the last few years but I’m still not perfect.

Anyway, my advice to all of you who are just starting out in your careers is:

Track your finances. Even if you don’t keep a rigorous budget, at the very least, create a spreadsheet that tracks your earnings, deductions (health insurance and other benefits), 401(K) contributions (and matches) and year-end balances, and your net worth. The act of doing so will force you to take a hard look at your finances and your priorities. Don’t like what you see? Then make changes.

One thing I learned over the weekend was that we aren’t doing as well with our 401(K) as I thought we were. In other words, we contributed a lot more than I thought we did based on the balance we currently have. This shouldn’t really be surprising when you consider the fact that we started contributing in 1997, which means we went through the tech bubble of 2000, 911, and the credit crisis of 2008. That said, our results have been buoyed by consistent contributions. As long as we don’t go through a massive depression, we should be fine over the long run.

A Baker’s Dozen of New Year’s Resolutions for Investors

Larry Swedroe sent me this email yesterday and I thought it was worth sharing.

Each new year brings with it the opportunity to get a “fresh start.” Among the traditional New Year’s resolutions are to lose weight, get in shape and quit smoking. The following are my suggestions for resolutions for investors.

1. If you don’t have a financial plan, the very first thing you should do is write one and sign it.

2. Make sure you investment plan does not take more risk than you have the ability, willingness or need to take.

3. Make managing the portfolio a year round job, checking for rebalancing and tax loss harvesting opportunities on at least a quarterly basis.

4. If you are working with an advisor who does not provide a fiduciary standard of care, fire him/her and hire one that does.

5. Separate the services of financial advisor, money managers, custodian and trustee.

6. Do not invest in any security that you don’t fully understand all the risks.

7. Avoid all actively managed funds and repeat to yourself “past performance is not a predictor of future performance.”

8. Do not stretch for yield. The main role of the fixed income portion of the portfolio is to reduce portfolio risk to an acceptable level.

9. Ignore all “expert” forecasts, recognizing that they have no value.

10. Do not buy any individual stocks or sector funds, recognizing that has more to do with speculating than investing.

11. Keep a diary of your predictions and review them every year.

12. Adhere to your plan, regardless of what the market does.

13. If you watch CNBC, make sure the mute button is on.

Larry writes a regular blog called Wise Investing for MoneyWatch.

Related books (affiliate links):

Wise Investing Made Simpler (Second in a series)

The Only Guide to a Winning Investment Strategy You’ll Ever Need: The Way Smart Money Invests Today

The Only Guide to a Winning Bond Strategy You’ll Ever Need: The Way Smart Money Preserves Wealth Today

The Only Guide to Alternative Investments You’ll Ever Need: The Good, the Flawed, the Bad, and the Ugly (Bloomberg)

Another Equity Indexed Annuity I Would Avoid

My friend, Allan Roth, posted an article today about an equity indexed annuity that he came across (you can read Allan’s piece here). It’s an interesting piece that details certain tricks that companies use in order to lure people into their products.

I want to focus on his trick #2 – “average annual” return. According to Roth:

If you actually possess the attention span to slog through the 373 page disclosure document, you would clearly see on page 189 that the term “average annual return” is defined as 1/12 of the first month plus 1/12 of the second month, etc. This translates to getting an expected tad over half the total annual return. Depending on the timing of the market increase, this could be either more or less than half. In this example, it yields about 54% of the total increase of the index.

I asked Allan for clarification on exactly how this works and this is what he said:

“You’d have to use 1/12 of the YTD returns. The 12th month would count the full year’s return but it would only weight 1/12 of the amount.”

Allan did not provide me with the name of this particular annuity so I don’t know all the details. He did, however, tell me that this particular EIA will not allow the account to have a negative return over the year. It’s important to note that this is over the year and not on a month-to-month basis.

In order to see how this would work in the real world, I used the 2009 monthly returns for the S&P 500 Index (NOTE: These are index returns and NOT total returns, which would include dividends). Here is what I found:

In case it’s not clear, the YTD column is what’s used to calculate how the account is credited. Each of the months are credited 1/12th of whatever the YTD return is on the index. Then, those amounts are summed to get the return for the year. So, for 2009, while the index returned 23.45% (not including dividends), this annuity was credited with a 5.01% return (BEFORE FEES!). If you take off the 2% for fees, the return is down to around 3.01%.

Who in the world would go for such a product? Clearly this particular product favors the insurance company. They get the dividends and the 2% management expense. If the insurance company invests in the underlying index, they get the spread in returns (23.45 – 5.01).

I would avoid these products. They are complicated and very different so that it’s very hard to make an apples-to-apples comparison. I would stick to a fixed immediate annuity or possibly a very low cost variable annuity. If you are enticed by a an equity-index sales pitch, do yourself a favor and get a second opinion BEFORE you sign any documents.

The Basics: Setting and Reaching Financial Goals

One of the most important areas of personal finance is setting and reaching financial goals. Why are financial goals important? Without them, it’s likely you won’t save and invest your money wisely. Having goals tends to help us focus on what’s important. Without them, we tend to allow life to just happen to us.

What Are Financial Goals?

There are many different kinds of financial goals:

• Get out of debt

• Create an emergency fund

• Pay cash for a new (or used) car

• Downpayment on a house

• College fund

• Retirement

The Goal-Setting Process

I’m not a goal-setting expert but I was able to come up with six steps in the goal-setting process:

1. Determine your goal and the amount of money needed to meet the goal.

2. Set a due date for meeting the goal.

3. Decided what investment vehicle that will be used to meet the goal.

4. Calculate the lump sum or periodic payment that will be needed to meet the goal.

5. Track your progress.

6. Reach your goal.


Let’s look at what the process looks like for someone saving up for a downpayment on a house. Let’s say in 5 years you desire a 20% downpayment on a $200,000 house ($40,000).

1. $40,000

2. 5 years (60 months)

3. Since the goal is relatively short-term, the savings will be kept in an interest-bearing savings account. For this exercise, we’ll use an annual interest rate of 1.28%.

4. To determine the lump sum or monthly payment necessary to meet this goal, you can use any number of online calculators, a regular calculator, or you can download this simple Excel Spreadsheet I put together for this post. Because interest rates on savings accounts are so low, the lump sum needed to meet a $40,000 goal in 5 years is really high at $37,500. If you’re going to reach the goal with monthly savings, you’ll need to save $645 per month.

5. For short-term goals, you’ll want to track your performance on a regular basis (monthly or quarterly) and make adjustments as necessary.

6. If all goes to plan, this goal should be met in five years (sooner if interest rates are higher or you can add more to your savings).

If you’ve never set and reached a financial goal, I urge you to give it a try.


16 Financial Tidbits for Newly Weds

My neighbors’ son is getting married in June. Thinking about his wedding, made me think of all the “advice” I have for this couple.

I have a few things I can share from my own experience of being married nearly 17 years:

1. PATIENCE! It takes time for your finances to grow. When I moved to Texas in 1992, the ONLY stuff I brought with me was what I was able to fit in my 1988 Buick Skyhawk. Nearly 18 years later, we have a house full of stuff!

2. Don’t rush into any large purchases. Give yourselves time to adjust to married life before you decide where to live or what to drive.

3. DON’T GET INTO CREDIT CARD DEBT! Avoid it like the plague. You’ll be thankful you did.

4. Create and stick to a BUDGET! It doesn’t have to be super-detailed and it doesn’t have to ruin your life. However, you need to have a grasp on where your money is going.

5. Put money aside for emergencies—even if it’s a small amount. It’s amazing how even a small cushion of a few hundred dollars can help in times of need.

6. Start saving for a down payment on a house as soon as possible.

7. Start saving for retirement as soon as possible. DON’T LET THE ASSET OF TIME GET AWAY FROM YOU. Even if you can only afford to save a small amount each month, save it.

8. If your finances are tight, cut out what you don’t need. My wife and I went without cable for many years.

9. Give each of you an allowance that can be spent on anything you wish and don’t criticize each other’s purchases.

10. Have a grocery budget and plan meal menus.

11. Take your lunch to work.

12. Buy some term life insurance.

13. Sit down together and write out a list of financial goals and talk through the prioritizing of those goals.

14. Decide whether or not you’re going to tithe or give to charity.

15. Seek financial advice from your parents (as long as they are good role models).

16. Read some basic books on financial planning and investing. A great place to start is Jeff Opdyke’s Financially Ever After: The Couples’ Guide to Managing Money and Bill Schultheis’ The New Coffeehouse Investor: How to Build Wealth, Ignore Wall Street, and Get on with Your Life*. I have not read Opdyke’s book but am very familiar with his style, having read his columns in the Wall Street Journal.

Thoughts? What would you like to offer?

*Affiliate links