Weighing an Investment That Promises No Risk

padthaiforlunch

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Weighing an Investment That Promises No Risk


I asked GoFigureNow, an actuarial and educational service that helps sales representatives calculate historical returns on index annuities, to calculate the return on an index annuity with an 8 percent cap, a participation rate of 100 percent and no spread. This sample product also would have paid a 5 percent bonus to the holder of the annuity upfront (a common sales tactic) and used something called an annual point-to-point crediting method for adding gains on the index to the account.


The result? The index annuity, which started with $100,000 in October 1998, would have had an account value of $176,478 as of Friday’s market close. The S.& P. 500 index fund, which also started with $100,000, would have actually lost money over 10 years, ending with a balance of $81,890.
The writer shows his dislike of annuities with:

So consider this alternative, which many financial planners suggest in various forms: Let’s say you have $10,000, and you don’t want to lose a cent of it. You could take just enough of that money and buy zero-coupon Treasury bonds that will be worth $10,000 in 10 years, thus guaranteeing you’ll get your principal back. Then, you could plop the rest in an S.& P. 500 index fund (to get some of that same upside that the index annuity promises).

And how might this strategy have worked out using the backward-looking comparison of the first example?

The bond would cost $74410. $25590 would have been invested in the S&P fund, which lost 22.11% (seems low, but we'll use their numbers). $25590 less 22.11% (we'll also ignore trading costs) is $19,932.

At the end of ten years, the EIA is worth $176,478. The zero-copon bond plus S&P money is worth $119,932.

DIY'ers short-changed themselves $56,546.



How might that work out for you 10 years from now? In a simulation examining 50,000 different outcomes using the same sample annuity I described above in the backward-looking comparison, and assuming an annualized S.& P. 500 return of 10 percent (7 percentage points from capital gains and 3 percentage points from dividends), the bonds-plus-index-fund strategy beats the index annuity 81 percent of the time. Take that presumed return up to 13 percent, and the index annuity loses 92 percent of the time.
Yes, let's all assume we'll get 10%-13% returns. :D:D
 
I like the examples!

Yes, and we all know that Fixed Annuities pay high commissions, cheat Seniors, have high fees and are created by evil monsters!

I can't tell you how many so-called financial experts who I see write articles on annuities know nothing about the product(s).

Little facts like knowing the differences between Fixed and Variable products are left out. You know, because they are all the same.
 
"assuming an annualized S.& P. 500 return of 10 percent"

 
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You guys have no clue what your taking about. Your math is way off. Here's how it's done.
 
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I suggest reading the full article, not just snippets. They make some great points in it.

In general, historical performance is no guarantee of future performance. Pick a different 10 year period, you'll get different results.

That said, indexed annuities are an interesting option for some right now.

Dan
 
True that results will vary over different ten year periods. The monte carlo simulation cited in the article stated that the zero-coupon invest the difference will outperform the FIA 80% of the time. Of course, it assumes 10% gains from S&P before transaction, management and fund fees.

FIA's are a great opportunity for everyone who doesn't know that the market has bottomed out, and who are willing to sacrifice some upward movement to eliminate the downside.

Agreed, read the whole article. I posted a link to it at the top of the thread.

Here is is again.

Weighing an Investment That Promises No Risk


oh, another snippet

“I have never seen an equity-indexed annuity that I understood, and I have never met anyone else who has,” Jay Hutchins, a certified financial planner with Comprehensive Planning Associates in Lebanon, N.H., wrote in an e-mail message. “Trying to figure out how they calculate your return is like unraveling a tangled ball of yarn.”
Begs the question of how much time he's put into understanding them. Perhaps he just wanted to be quoted in the NYT and he makes his money on AUM.
 
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I think one important thing is overlooked in every scenario that financial planners put together based on ANY historical period before now.

Personally, I seriously doubt that the averages from any post WWII period will ever again be a model for what is going to happen in the future. Why? Because American expansion after the war was enormous. However, we have sent our industry and capacity to expand overseas. If you look at the US stock market prior to the Depression, you will see 2% as typical growth and you will see decades-long periods of no growth. That, I think, is what we are going back to.

If you buy into this argument, and every senior I discuss this with sees where I am coming from with it, then fixed annuities look damn good. Indexed annuities with generous minimum returns look better still. The tremendous debt we are taking on is going to finish us off at some point. I seriously think that if the US stays on the current track, the US will have to default on all of it's debt at some point. That means the 70% of debt that is foreign-owned will be worthless overnight.
 
Ugh. That is not a good scenario in any way, shape, or form. I do think that a lot of the indexers forget that dividends aren't included in returns.....
 
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