Q: A friend of mine has been telling me about the advantages of indexed annuities.
They sound too good to be true.
I’ve also read that it may still be possible to actually lose money (not just get a lower return). Can you explain that?
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Also, how does the insurance company make money? I don’t get it.
A: Fixed index annuities sound a lot better than they are because most of us have selective hearing. We hear what we want to hear. And salespeople are trained to provide it.
What we want to hear is this: “Yes, I’ve got a risk-free, but stock market-like return for you!”
The most common way people lose money in these contracts is the cost of getting out of the contract once it has been entered.
You can find yourself eligible for only 90 percent (or so) of your original investment — after losing your index-based credited interest.
Many elderly people discovered this only when they wanted out.
What investors need to understand is that insurance companies are like banks:
They are investment intermediaries.
This means they take our money and invest it, hoping to make money on fees or by earning a higher return than they have promised to us.
If you invest in a variable annuity, the way the insurance company will make money is clear and explicit. They collect an insurance fee.
They may make additional money on the expense ratios charged for the investment funds offered.
How the insurance company makes money in a fixed index annuity contract is a deeply buried secret because it is built into the crediting formula used to calculate your return.
The marketing and sales incentives are large enough to make these contracts very popular with sales agents.
If reader mail (and personal mail) is any indication, efforts to sell fixed index annuities dominate all other types of annuities.
Also important, the insurance company may change the crediting formula after you have purchased the annuity, so future returns may be entirely unrelated to anything you are expecting.
I think the technical phrase for this is “buying a pig in a poke.”
Q: I am looking for some suggestions on where to invest money during a downturn in the economy.
I am in my mid-40s.
I usually invest in index funds such as the Vanguard 500 Index but feel a downturn may be headed our way.
A: Many people predict market turns, but few are successful, particularly if you consider that you also have to pick a good time to get back in after you have, perhaps, successfully predicted the time to get out.
So I’m in the Jack Bogle school of investing: Pick a level of risk you can stand and hold it.
Add regular rebalancing, and you’ve got a pretty good formula for buying more of what’s down and less of what’s up.
Copyright 2013, Universal Press Syndicate