CDs vs Bond Funds vs Equity Indexed Annuities vs Mutual Fund
Mel
concern over "asset preservation" is a major factor. I must figure out
SOON what I will do with my modest pile of funds.
I gather from reading through lots of groups like this over the past
few months the following:
CDs -- very low risk, and a yield which occasionally won't even keep up
with inflation, not very liquid
Bonds/bond funds -- low risk, and maybe a better yield than CDs,
somewhat liquid
EIAs -- almost no chance of losing much of the principal, better yield
than CDs or bonds, but expenses and caps, etc., keep the yield well
less than a S&P 500 indexed fund, highly penalized liquidity
Mutual Fund -- nearly as risky as stocks, far superior yield
(probably), highly liquid
The one thing that I am having a hard time resisting is the safety for
my modest pile (a few hundred thou) in an EIA. I know, I know, I
know,... they have all kinds of expenses and commissions and caps and
participation rates,.. but those things to me are just complicated
ways of explaining why they underperform S&P 500 funds somewhat. When
all the dust settles, it still appears that an EIA will typically earn
more than CDs and bonds, and somewhat less than indexed mutual funds,
but have than HUGE benefit of protecting the modest pile.
Over the past several years it appears that an EIA would have earned a
few percent less than a typical mutual fund, but would have never put
the principal at risk. How true is this speculation?
I'm overwhelmed. Well,.. at least whelmed. What is the best solution
for a guy that puts a large importance on asset preservation, but would
like some decent ROI?
Thanks for any info,
Mel
PeterL
Mel wrote:
> Like most folks, I want lots of income with low risk. I'm 60, so my
> concern over "asset preservation" is a major factor. I must figure out
> SOON what I will do with my modest pile of funds.
EIA, two words: stay away.
Ed
Is it possible to lose money in an EIA?
Yes. Many insurance companies only guarantee that you'll receive 90% of the
premiums you paid, plus at least 3% interest. Therefore, if you don't
receive any index-linked interest, you could lose money on your investment.
One way that you could not receive any index-linked interest is if the index
linked to your annuity declines. The other way you may not receive any
index-linked interest is if you surrender your EIA before maturity. Some
insurance companies will not credit you with index-linked interest when you
surrender your annuity early.
"Mel" <mri...@dr.com> wrote in message
news:1166156298....@f1g2000cwa.googlegroups.com...
rono
Good job doing your homework. I'd avoid annuities like the clap from
any insurance company and for those rare occasions (not yours) that
they are appropriate, I'd go with either Vanguard or TRowePrice - as
they will pimp you less.
That said, what you basically are looking for is a risk averse asset
allocation that will focus on preservation of capital while returning a
steady stream of income. Note that an asset allocation is a MIX of
equities, bonds and cash instruments and that's what you need . . . a
MIX.
A rule of thumb often used is to subtract your age from 100 and that's
the portion you need to devote to equities. In your case this would be
40% which would leave either 40-50% for bonds and the remainder for
cash. If this seems too risky, tone down the equity portion to say 30%
and raise both the bonds and cash portions. And do NOT disregard
equities as you need some exposure to protect yourself from inflation.
Historically, stocks return ~12%, bonds 4-6%, and cash 2-3%. This is
why you need some of each. Another rule regarding cash is to have 3
years worth of expenses in cash type stuff.
You can easily find good stock mutual funds that are conservative and
have a decent return. For example, you could go with Growth & Income,
Equity Income, Dividend Growth and Capital Apprecation type funds
(making sure to have some International exposure) that would all have a
steady stream of income and mostly have some inherent capital
appreciation type gains too.
For bonds, there are also real nice funds available like Vanguard's
Total Bond Index fund and every other sort of bond fund you could
desire (short term, intermediate, long, inflation protected, etc.)
Again, you still want to have some int'l exposure here with both Int'l
Bonds and also a dab in Emerging Mkt Bonds (funds exist for both).
For cash, there are money market mutual funds, but for pure safety,
particularly if this is taxable money, you cannot beat CD's. What you
do however, is to set up a CD Ladder so that every year another one
comes due that you roll over. For example, split the cash portion of
your allocation (other than living expenses) into 5 equal piles. With
each pile buy a CD - 1 year, 2 years, 3 years, 4 years, 5 years. In
one year when A comes due, roll it over into a 5 year. Repeat this
process until all 5 are for 5 years each with one coming due each year.
And if this is taxable money, you need to watch your tax bill. For our
taxable money (58 yo), we own about 50% blue chip dividend paying
stocks, 33% in a muni bond fund from my state (most states have them if
not open ended mutual funds, then closed end and mine's closed). This
is yielding 5.5% TAX FREE. Got 5% in a very high yielding mutual fund
and the rest in growth type 'story' stocks that are near and dear to my
heart. Note that there is NO cash in this acct as that is in the bank
in savings, CD's and money market.
just some thoughts and ramblings.
The big thing Mel, is to continue to do your homework, move slowly and
frankly, cut your freaking arm off before you sign up for an annuity.
Literally.
peace,
rono
Flasherly
Mel wrote:
> EIAs -- almost no chance of losing much of the principal, better yield
> than CDs or bonds, but expenses and caps, etc., keep the yield well
> less than a S&P 500 indexed fund, highly penalized liquidity
> Mutual Fund -- nearly as risky as stocks, far superior yield
> (probably), highly liquid
>
> The one thing that I am having a hard time resisting is the safety for
> my modest pile (a few hundred thou) in an EIA. I know, I know, I
> know,... they have all kinds of expenses and commissions and caps and
> participation rates,.. but those things to me are just complicated
> ways of explaining why they underperform S&P 500 funds somewhat. When
> all the dust settles, it still appears that an EIA will typically earn
> more than CDs and bonds, and somewhat less than indexed mutual funds,
> but have than HUGE benefit of protecting the modest pile.
>
> Over the past several years it appears that an EIA would have earned a
> few percent less than a typical mutual fund, but would have never put
> the principal at risk. How true is this speculation?
>
> I'm overwhelmed. Well,.. at least whelmed. What is the best solution
> for a guy that puts a large importance on asset preservation, but would
> like some decent ROI?
The typical equity-indexed annuity is not registered with the SEC.
Losses may occur if a) cancelling early, b) not fulfiling a minimum of
purchase payments, and c) failure to realize index-linking when not
held sufficient and to include maturity. Understand how the link is
derived. A percentage link, a percentage of an index increase, or
whether capped, capped not to exceed an predetermined amount of an
index increase. Spreads within margins may be given on a take from an
index value for adminsitering the annuity. When index value is
determined by ratcheting, any increase during the year is valid.
Interest value earned at an entry point into an annuity may also not be
assessed unit the contract is completed. Value may be set at
predetermined contractual setpoints for a highest applicable reference.
I don't see it as hugely secure in a comparitive sense. Without a
contract is tantamount to being suspect, and can't be used to readily
dismiss CDs, bonds, or investments with low-risk ratings. Underlying
factors have to be weighed out on a table of comparable market risks
for vantage points to determine how an annuity contract significantly
differs. For what contractual investment wording is worth, most say,
the only free lunch handed out on Easy St. is diversity.
Mark Freeland
> concern over "asset preservation" is a major factor. I must figure out
> SOON what I will do with my modest pile of funds.
Most of the responses have been addressing the annuity aspect of an
equity-indexed annuity. An immediate annuity can provide you a lifetime
income stream (typically the annuity has no value after you die). Is this
what you are interested in, or are you simply looking for investments that
generate income?
The reason for this question is that one can have equity-indexed income
investments that are not annuities, and annuities that are not
equity-indexed. The fact that you list CDs, bonds, etc. suggests that you
don't care about a guaranteed income stream (the main advantage of an
immediate annuity).
While I'm not (yet) fond of them, principal protection notes - PPNs
(essentially, bonds linked to some index that can be as common as the S&P
500, or as esoteric as a currency exchange rate) can provide the potential
for greater gains than "vanilla" bonds. But you are getting that potential
gain at a cost of higher risk - not downside risk (principal is
"protected"), but rather in the risk of lower (non-negative) returns than
you would get with a fixed rate bond or CD.
You could ladder PPNs the same way as one would ladder CDs, so that you
would have a series of PPNs maturing at different times to provide cash
flow. (This would be necessary because they are not especially liquid.)
This should give you a reasonable overview of PPNs:
http://personal.fidelity.com/products/fixedincome/ppn_overview.shtml.cvsr
Be very sure you understand participation rate. One of the PPNs currently
listed shows a 103% participation rate for an S&P 500-indexed note. That
doesn't mean you'll do better (103%) than the S&P 500, because the index
doesn't include the value of dividends, which is a significant part of the
total return. You are only looking at the change in stock prices.
In short, TANSTAAFL. You want greater return, you'll have to take greater
risk. Principal protected vehicles (whether EIAs, PPNs, or other vehicles)
make the risk you take asymmetric (the downside range is more limited than
the upside), but any risk reduction costs, and usually asymmetric risk
reduction costs more (though it makes you feel better :-).
On mutual funds - Lipper rates funds on a variety of different scales,
including one for "preservation of capital". You might want to take a look
at their ratings, and think of funds that rank highest on that scale.
http://funds.reuters.com/lipper/retail/reuters/fundScreener.asp?type=f
Something like Fidelity's Floating Rate High Income fund might give you a
small boost with small risk. Ultrashort/short term bond funds, such as
MetWest Ultra Short, or Vanguard Short Term Investment Grade can also do a
bit better than cash with small risk.
Going into equities increases risk, but for a relatively long term
investment (you're only 60), a mix of 80% fixed income/20% equity is still
generally regarded as very conservative, and depending on the size of your
portfolio and projected expenses, may need some of that growth. Going up
slightly more in equity, you could look at conservative allocation funds
like Vanguard Wellesley Income. That will give you substantially more
appreciation, but with the occasional poor year (1 out of the last 8).
You have to decide what is comfortable for you.
Mark Freeland
BnetO...@sbcglobal.net
Flasherly
some points to consider. Like options and prevailing interest rates,
which form his bottom line. Another time, another market, just not the
one we're in. Another vehicle (not mentioned) is equity indexed CDs.
FDIC insured, with profit being contingent upon a rise from the index.
Up to and better than say a 6% CD for the index break through, while
nothing more than 6% can be lost, having not bought the CD in the first
place, if an equity-indexed CD enters into negative losses for an end
return on principle only. An EICD is a 5-year minimum commitment and
may take some searching to procure.
http://www.farmcreeksecurities.com/Sound_Investor21_Equity-Linked_Annunities_10-26-05.html
Mel
Mel
nothing really new. The basic message is: Diversify,.. put some in
lowrisk-lowreturn, put some in midrisk-midreturn, put some in
highrisk-highreturn. Vary proportions to suit. Hedge bets as
necessary.
Except for the fact that statistically you usually win in the stock
market (long term), it's like going to Reno and playing roulette. Bet
red or black to win the most often but win the least each time
(lowrisk-lowreturn). Bet on individual numbers to win the most with
each win, but lose often (highrisk-highreturn). If you want to hedge
your bets, bet on red, bet on one of the columns, and bet on a few
numbers. Diversify.
While I can't fault this time-honored strategy, it still seems like (at
my stage in life) that having my modest pile in something that will NOT
disappear in a stock market crash has a lot of value.
No matter how many disadvantages are brought up about EIAs (I readily
concede they are several and valid), it still seems to me that overall
they earn a little more than CDs or bonds, and yet have a safety factor
none of the alternatives can beat. Yes, they stink earnings-wise when
compared to good funds, but good funds turn bad rapidly when market
hysteria takes hold.
To restate: EIAs earn 5% - 8% and have little or no possibility of
vaporizing my modest pile.
I am very leery of EIAs simply because all of you folks who have a lot
more experience in this are so revulsed by them. Still, I have not
heard any outright refutation of the concept that they generally earn
moderately well and have a very low catastrophe factor.
I really do appreciate all the thoughtful, well-stated responses.
Ed
"Mel" <mri...@dr.com> wrote
> I am very leery of EIAs simply because all of you folks who have a lot
> more experience in this are so revulsed by them. Still, I have not
> heard any outright refutation of the concept that they generally earn
> moderately well and have a very low catastrophe factor.
>
> I really do appreciate all the thoughtful, well-stated responses.
Mel, it's always a trade off. You get some degree of safety with EIA's for
added expenses and lower returns.
With treasuries you can do almost as well, no state taxes, and you have no
risk of losing money.
If you bought an S&P500 index fund you would have market risk but should do
much better over time and the fees are very low, only 0.10% at Fidelity. If
you buy a balanced index fund you could do almost as well as the index with
less risk. Always a trade off.
P.Schuman
> have a decent return. For example, you could go with Growth & Income,
> Equity Income, Dividend Growth and Capital Apprecation type funds
> (making sure to have some International exposure) that would all have a
> steady stream of income and mostly have some inherent capital
> appreciation type gains too.
>
on going with what type of fund given age, 2007 outlook, etc ?
Growth & Income
Equity Income
Dividend Growth
Capital Apprecation
PeterL
Mel wrote:
> You must work for Microsoft.
Huh?
Mark Freeland
> No matter how many disadvantages are brought up about EIAs (I
> readily concede they are several and valid), it still seems to me that
> overall they earn a little more than CDs or bonds, and yet have a safety
> factor none of the alternatives can beat.
I provided pointers to principal protected notes, which can have 100%
downside protection. What more protection do you get with EIAs? What is the
benefit to you of an annuity wrapper, when you can get the same investment
vehicle without the wrapper (and without its cost and added complexity)?
You can get even more protection with an equity linked CD (same idea, except
offered in CD form, meaning that the principal is guaranteed by the
government, rather than the issuer - I consider that a safety factor that an
EIA, or PPN, cannot beat). Flasherty mentioned these.
http://www.sec.gov/answers/equitylinkedcds.htm
http://www.guardingyourwealth.com/annuities/articles/EquityLinkedCDs.htm
Do you understand the difference between a high water mark EIA, an annual
ratchet, and a point-to-point valuation? To quote the SEC, "before you
decide to buy an equity-indexed annuity, you should understand how each
feature works and what impact, together with other features, it may have on
the annuity's potential return."
http://www.sec.gov/investor/pubs/equityidxannuity.htm
Most of the posters here have a revulsion toward annuities, period. I
don't, and have advocated them under certain circumstances. In your case, I
just don't see what the annuity (as opposed to the type of underlying
investment - equity-linked) is doing for you.
Mark Freeland
BnetO...@sbcglobal.net
Mel
asset protection. The articles everyone has referenced here don't seem
to show any schemes having complete asset protection that earn
significantly more than EIAs, even after all the hype and costs have
been finalized.
Yes, I've been beating myself silly with research on this, so I
understand the diffs between the various EIA indexing methods.
One thing that was pointed out to me by a coworker is that in the group
of investment vehicles that are in the few to several percent return
category, as long as I have asset protection, I'm not going to be
absurdly rich using one solution, nor devastated by using another. The
worst consequence would be 2 or 3 percent earnings difference.
Maximizing the earnings is very desirable to be sure, but not losing
any of it is HUGE.
You said there are ways to protect assets that might be as good or
better than EIAs. That sounds quite reasonable, but still there does
not seem to be one solution that is far and away superior to another.
Let me ask for this info in another way. With this situation:
-- $400k in liquid assets (earning about 8% taxable, typically)
-- $200k in IRA/401k funds
-- $2,500 monthly USAF pension
-- Married, both retired
-- Requirements: asset protection, $2,000 monthly income
What would your strategy be?
Thanks much for all your comments.
rono
You might have hit on the solution to your quandry.
Mel wrote:
>
> One thing that was pointed out to me by a coworker is that in the group
> of investment vehicles that are in the few to several percent return
> category, as long as I have asset protection, I'm not going to be
> absurdly rich using one solution, nor devastated by using another. The
> worst consequence would be 2 or 3 percent earnings difference.
> Maximizing the earnings is very desirable to be sure, but not losing
> any of it is HUGE.
Mel, if some of the safer vehicles have comparable returns, then I'd go
with whatever gave me more flexibility in the future . . . and with the
surrender charges associated with annuities - that would automatically
eliminate them as an option. All things being equal, the annuity
choice is a One-Way choice due to the surrender charges. Your other
choices don't commit you for life like the annuity does.
Another way of looking at this is that you do NOT take the annuity
choice now, you can still take it later - even if you have to approach
a 3rd party house like Price or Vanguard or Fidelity and get a Fixed
Annuity. However, if you take the annuity choice now, the surrender
charges obviate being able to change your mind later.
> Let me ask for this info in another way. With this situation:
> -- $400k in liquid assets (earning about 8% taxable, typically)
> -- $200k in IRA/401k funds
> -- $2,500 monthly USAF pension
> -- Married, both retired
> -- Requirements: asset protection, $2,000 monthly income
> What would your strategy be?
Ah, now we're cutting to the chase.
The $400K I'd probably put $100K into a CD ladder (5 CD's at $20K each
for 5 years with an annual rollover of the oldest into a new 5 year -
start with 1, 2, 3, 4, 5 year CD's and each year rollover the one that
comes due to a 5 year). The other $300K - I'd have $100K in blue chip
dividend payers and the other $200K in munis from my own state. Some
of the larger states have open ended muni mutual funds, but most EVERY
state has at least a closed end fund option. Mine is paying 5.5% TAX
FREE. If you need any income from this stash, I'd keep it to no more
than 5% max.
As for the IRA/401K, I'd probably go with 40/50/10 equities/bonds/cash
so that you can still have some growth for inflation protection and
security. If you're very cautious, make it 30/60/10. And as with your
other stash, I'd limit withdrawals to 5% or less if at all possible.
And if you could keep both withdrawal rates less than 5% - say 3-4%,
all the better.
just some thoughts,
rono
Mel
I like your "cut to the chase" comment.
Your solution sounds very mainstream, and I can't fault it at all. It
appears you subscribe to the "diversify conservatively" philosophy.
If the ragheads start exploding dirty nukes in Manhattan, North Korea
starts hosing nukes at South Korea, and China rolls over Taiwan, and
the democrats have their way, it seems the part of my modest pile
immediately at risk would be the $100k in blue chips, and the $60k in
the 30/60/10 IRA mix. If that $160 lost 50%, I'd be deeply annoyed.
On the other hand, if things stay somewhat calm, the democrats are held
in check, and Harry Dent is correct, what would you estimate the growth
rate for your recommended mix to be?
Another question. Since you show such a rational approach (like many
of the others here), what would your recommendation be for pulling
about 4% out of my modest pile for supplemental income, consideration
the most tax advantageous way to do so? In other words with the
conservatively diversified approach you recommend, how would it best be
set up to minimize the tax burden if I needed about $2,000 monthly to
for supplemental income?
thanks
Ed
> Rono -- you focus on the issue at hand quite well.
>
> I like your "cut to the chase" comment.
>
> Your solution sounds very mainstream, and I can't fault it at all. It
> appears you subscribe to the "diversify conservatively" philosophy.
>
> If the ragheads start exploding dirty nukes in Manhattan, North Korea
> starts hosing nukes at South Korea, and China rolls over Taiwan, and
> the democrats have their way, it seems the part of my modest pile
> immediately at risk would be the $100k in blue chips, and the $60k in
> the 30/60/10 IRA mix. If that $160 lost 50%, I'd be deeply annoyed.
>
> On the other hand, if things stay somewhat calm, the democrats are held
> in check, and Harry Dent is correct
Dent, which revision?
rono
Mel wrote:
> Rono -- you focus on the issue at hand quite well.
>
> I like your "cut to the chase" comment.
>
> Your solution sounds very mainstream, and I can't fault it at all. It
> appears you subscribe to the "diversify conservatively" philosophy.
>
> If the ragheads start exploding dirty nukes in Manhattan, North Korea
> starts hosing nukes at South Korea, and China rolls over Taiwan, and
> the democrats have their way, it seems the part of my modest pile
> immediately at risk would be the $100k in blue chips, and the $60k in
> the 30/60/10 IRA mix. If that $160 lost 50%, I'd be deeply annoyed.
I don't see it, but who knows. For these reasons, I've long been an
advocate of having a small percentage of ones assets in something
substantial like precious metals. 3-5% range at most and pick your
poison - mutual funds like TGLDX or UNWPX - individual mining stocks or
even bullion in the form of American Eagles. I've got a little of all
of them for core holding, but am speculating with some more.
> On the other hand, if things stay somewhat calm, the democrats are held
> in check, and Harry Dent is correct, what would you estimate the growth
> rate for your recommended mix to be?
On average, I'd rather be conservative than speculative with pure
retirement monies - and I'd rather be conservative about my growth rate
projections. Way too many people swear they're going to turn 8-9% and
that's simply a pipe dream. I'd figure 5-6% on average and to the
degree you can make that tax efficient or exempt, you raise part of it
to the 8% range.
And keeping the Blue Meanies at bay is crucial to maximizing your
growth rate.
> Another question. Since you show such a rational approach (like many
> of the others here), what would your recommendation be for pulling
> about 4% out of my modest pile for supplemental income, consideration
> the most tax advantageous way to do so? In other words with the
> conservatively diversified approach you recommend, how would it best be
> set up to minimize the tax burden if I needed about $2,000 monthly to
> for supplemental income?
But of course. I'd plan on pulling out 4% without problem. Others may
disagree, but I'm a believer in paying the Blue Meanies later rather
than sooner. With this in mind, I'd move to continually lower my
current tax burden by sellling off things that you're paying taxes on
now and retaining things that either exempt or deferred.
Mel, the last reason why I would NOT lump things into some sort of
annuity is that I see retirement like a foot stool. The more legs
under your stool, the sturdier it is. 2 legs better than 1, 3 better
than 2, 4 better than 3, etc.
Now take inventory of YOUR stool and count the legs and while you're at
it, consider how strong each of them is. Social Security is a leg,
pension, IRA, 401, Roth, home equity, savings, income property,
retirement job, smart kids with good jobs, etc. These are some to
consider. Now, are there any legs you can add? Are there any weak
legs you can strengthen?
The nut is that you simply must disversify your retirement vehicles
just like you diversify your portfolio.
good luck,
peace,
rono
Mel
The latest.
Mark Freeland
>
> My thinking was that the EIAs provided a little more return for their
> asset protection. The articles everyone has referenced here don't seem
> to show any schemes having complete asset protection that earn
> significantly more than EIAs, even after all the hype and costs have
> been finalized.
I've repeatedly pointed out that structured notes, e.g. principal
protected notes, are essentially the same investment outside of an
annuity. But you don't incur the additional cost of the insurance
wrapper, the sales commission, etc. that are paid for by receiving a
lesser return from the fixed annuity. You haven't responded to my
question about why you want the annuity wrapper when you can get the
same investment without the wrapper.
> Yes, I've been beating myself silly with research on this, so I
> understand the diffs between the various EIA indexing methods.
Then you understand structured notes, and recognize the risks involved
(default risk, same as with the insurer; market risk; inflation risk;
etc.)
> One thing that was pointed out to me by a coworker is that in the group
> of investment vehicles that are in the few to several percent return
> category, as long as I have asset protection, I'm not going to be
> absurdly rich using one solution, nor devastated by using another. The
> worst consequence would be 2 or 3 percent earnings difference.
Not so. One can find CDs paying 6% (I picked one up a couple of months
ago). Get a structured note and you could get 0%. Get an annuity, and
as Ed pointed out, you could get less than 0, depending on how the
underlying index performed. That's the worst consequence (assuming the
insurance company doesn't go out of business or default).
> Maximizing the earnings is very desirable to be sure, but not losing
> any of it is HUGE.
> You said there are ways to protect assets that might be as good or
> better than EIAs. That sounds quite reasonable, but still there does
> not seem to be one solution that is far and away superior to another.
Suppose you had a choice of two CDs. One paid 4.75% and had an early
withdrawal penalty of all interest. The other paid 5.5% and had an
early withdrawal penalty of 30 days interest. The latter is not far
superior to the other (interest within 2-3%, same level of security);
does that mean that you'd settle with the former? IMHO, that's what you
are doing by insisting on the annuity wrapper (unless you derive some
other, still unstated, value from that wrapper).
> Let me ask for this info in another way. With this situation:
> -- $400k in liquid assets (earning about 8% taxable, typically)
> -- $200k in IRA/401k funds
> -- $2,500 monthly USAF pension
> -- Married, both retired
> -- Requirements: asset protection, $2,000 monthly income
> What would your strategy be?
If I had a way to earn 8%, taxable, I'd be delighted, and stick with
that. I just bought a triple tax exempt (AAA rated) muni, 10 years,
yielding about 4 1/2% (not for my account). I've mentioned CDs up to
6%. Go above these rates, and you are putting return at risk; not 2%
risk, but as mentioned above, 6% risk.
If you really want to go the structured note (or more overhead EIA)
route, you can still do better by building it yourself - a combination
of options, bonds, and equity will give the same downside protection
with greater returns - this is what the structured notes do, but you can
do it yourself and avoid the middleman.
Here's a Kiplinger Retirement Report article (Sept. 2006) entitled:
"Indexed Annuities: Too Good to be True".
http://www.kiplinger.com/retirementreport/features/archives/2006/09/Cover_Sep2006_02_01.html
A couple of quotes: "'There are probably 100 different ways to credit
interest, and you literally need a degree in industry methodology to
understand,' says Scott Dauenhauer, a CFP at Meridian Wealth
Management."
"Craig McCann, a former SEC economist and president of Securities
Litigatin and Consulting Group ... sayss investors can do as well or
better with a simple portfolio of Treasuries and a diversified stock
fund."
He has a paper discussing equity-linked notes at:
http://www.slcg.com/documents/StructuredProductsWorkingPaper_-_11_2_06_-_with_Releases.pdf
"Are Structured Products Suitable for Retail Investors"
As I said, these are the same thing as EIAs without the insurance
wrapper.
I haven't had the chance to carefully read the whole paper, but you
should take a look at section III (starting on pdf p. 8), that compares
three different structured notes with a mix of Treasuries and equities.
If nothing else, it will give you a flavor of how EIAs can set their
rates of return. With Monte Carlo simulations, he shows that one can do
better than any of these particular rate schemes 100% of the time.
His conclusion: "Equity-linked notes are complex, opaque and expensive -
and the more complex and opaque they are, the more expensive they are.
Even with the best disclosure materials and the most thoroughly trained
and supervised registered representatives, it is unlikely that retail
investors can understand the risk-return tradeoff and the costs being
incurred in some of hte complex equity-linked notes and stuctured
products currently being marketed."
And that comment is about SEC-licensed reps, as contrasted with the
insurance salespeople who are selling you the EIA.
"Moreover, we find simple portfolios of stocks and bonds can be
purchased and periodically rebalanced which will yield more wealth at
maturity than an investment of any of the three equity-linked notes we
have analyzed at issuance whatver the level of the S&P 500 ... These
products add nothing to the retail investors' portfolios that can't be
acquired from investments 'already available in the market in the form
of less risky, less complicated, or less costly products'..."
And that is not even counting the insurance wrapper.
You asked for a prescription (what would I do) - read the paper.
--
Mark Freeland
BnetO...@sbcglobal.net
Mel
thorough. Rono,.. same comment.
I get the idea, now. If one wants the advantages of an EIA, one
doesn't have to put up with the disadvantages. A PPN will give the
same protection, have lower expenses, and about the same return, but
without the "cumbersomeness" of an insurance company's annuity. I
certainly had no attachment to the "wrapper" of an EIA. I only cared
about the seeming benefit of good protection, moderate earnings and tax
benefits.
I haven't seen CDs anywhere near 6%. I'd be very interested to know
where I can get something like that in case I get a wild hair and want
to do the laddered CD thing.
The paper you referenced had the statement, "we find simple portfolios
of stocks and bonds can be purchased and periodically rebalanced which
will yield more wealth at maturity than an investment of any of the
three equity-linked notes we have analyzed at issuance whatver the
level of the S&P 500." This brings up one other factor. I am not
skilled enough to continually fool around with portfolios (nor am I
entertained with the effort). I don't want to have to spend hours per
week monitoring, buying, selling, etc. "Periodically rebalanced" says
to me my angst level would be increased because I'd have to reassure
myself that I had the correct mix all the time.
On a related subject,.. here's something that was suggested to me. Use
$300k of my $400k to buy $400k's worth of zero-coupon treasury bonds,
and leave the remainder in the mutual fund I've had since 1982 that has
earned an average of 11% or so (over the last two decades), and has
always had a Morningstar risk rating of low. The suggestion was made
on the basis that with these types of bonds, 3/4 of my "modest pile" is
never in danger of disappearing, the earnings are okay for bonds, the
expenses are low, and I know what the overall interest will be when the
bonds mature. What thinkest thou of that?
What are the tax implications of a scheme like this?
Again,.. thanks intensely for sticking with me on this.
Happy New Year, everybody!!
humbly,
mel
Mark Freeland
> I haven't seen CDs anywhere near 6%. I'd be very interested to know
> where I can get something like that in case I get a wild hair and want
> to do the laddered CD thing.
One has to shop around, mostly for credit unions, and recognize that many of
these never show up on bankrate.com. For example, one can currently get
6.25% (3-7 year CDs) at the Pentagon Federal Credit Union
https://www.penfed.org/productsAndRates/checkingAndSavings/moneyMarketCertificatesJan.asp
One is eligible to join by simultaneously joining the National Military
Family Ass'n
https://www.penfed.org/membershipApplication/eligibility/elig10.1.2.asp
> The paper you referenced had the statement, "we find simple portfolios
> of stocks and bonds can be purchased and periodically rebalanced which
> will yield more wealth at maturity than an investment of any of the
> three equity-linked notes we have analyzed at issuance whatver the
> level of the S&P 500."
It also says that even without rebalancing, one has a 94% - 97% chance of
doing better than the relevant index.
> This brings up one other factor. I am not
> skilled enough to continually fool around with portfolios (nor am I
> entertained with the effort). I don't want to have to spend hours per
> week monitoring, buying, selling, etc. "Periodically rebalanced" says
> to me my angst level would be increased because I'd have to reassure
> myself that I had the correct mix all the time.
Two points - (1) Figure 1c shows that even without rebalancing at all, the
60/40 stock/bond initial mix does better over the 10 year period analyzed
unless the stock index ended the 10 year period down more than 1/2 of its
original value, or if the stock index more than quadrupled during that
period. Otherwise, a set-and-forget balanced portfolio does better.
(2) "Periodic rebalancing" can mean something as simple (or to use the
paper's term, "crude") as looking at the portfolio once a year, and bringing
it back to the original mix. (If it is in a taxable account, you might want
to do this every year-and-a-day, so that any gains recognized would be long
term.)
> On a related subject,.. here's something that was suggested to me. Use
> $300k of my $400k to buy $400k's worth of zero-coupon treasury bonds,
> and leave the remainder in the mutual fund I've had since 1982 that has
> earned an average of 11% or so (over the last two decades), and has
> always had a Morningstar risk rating of low. The suggestion was made
> on the basis that with these types of bonds, 3/4 of my "modest pile" is
> never in danger of disappearing, the earnings are okay for bonds, the
> expenses are low, and I know what the overall interest will be when the
> bonds mature. What thinkest thou of that?
That's probably reasonable. While the paper uses a 60/40 mix, a 25/75 is
not unreasonable for someone very risk adverse. I would not go below 20%
equity - there is minimal impact on risk at that point, only lower returns.
I don't think zeros yield appreciably more or less than coupon (periodic
interest-paying) bonds. One gives up a bit of yield on treasuries, because
there are many people who are willing to pay a premium for the added
security of a US government backed security. Corporate bonds, even AAA, do
add real risk, and require study to build a well-diversified portfolio (to
reduce that risk); so getting a little less interest for the greater
security can be a reasonable tradeoff.
Zeros vs. coupon bonds - this is a tradeoff of interest risk vs.
reinvestment risk. With a zero, one never has the headache of reinvesting
the interest payments (no payments ot reinvest), and one is always sure of
the interest one is getting on every dollar. With a coupon bond, with each
interest payment, one has to figure out where to put the money, and it could
get a higher or lower interest rate than the original bond (hence
reinvestment risk). Since it doesn't sound like you'd be spending the
payments, zeros may solve the problem of what to do with the money.
"Interest rate risk" refers to the way the market price of your bond varies
with interest rates. If you want to sell a bond before maturity, you may
get more or less than you paid for it, depending on whether interest rates
went down or up, respectively, since you bought it. If you hold to
maturity, this isn't as big an issue. Zeros are more sensitive to interest
rate changes (because, for the same maturity bond, they have longer
duration). Again, hold to maturity, and this becomes a minor point.
> What are the tax implications of a scheme like this?
Treasuries are exempt from state taxes, so they are more valuable to people
in high income tax states. (That's another reason why they pay less than
corporate bonds.) They are taxable on a yearly basis on "phantom" interest.
That is, you buy the bond at a discount, that builds in a certain rate of
"appreciation". That appreciation is treated for tax purposes as interest
payments that accrue periodically, but are paid at maturity. These
"phantom" accruals are taxable each year.
http://www.sec.gov/answers/zero.htm
Finally, I hasten to add that this is not intended as advice, but provided
merely for information purposes. It is your decision, and I am not making
recommendations or specific suggestions.
Mark Freeland
BnetO...@sbcglobal.net