A 64-year-old woman asked her financial advisor, “Why is the annuity a good idea?” He replied that it gives her what she wants, a guaranteed income. That is the key. His approach solves problems by giving people what they want. Wants are emotionally based. Needs are comparatively fact-based.
Rather than pander to emotional desires, I try to convince clients to do what I would do if I were in their situation. A fiduciary does not begin with the emotional component as the objective.
As interest rates increase over the next few years, it will be easier to generate income from a diversified portfolio. While interest income will be taxed as ordinary income, capital gains and qualified dividends are currently taxed at lower rates. Lower expenses, the step-up in basis for non-qualified (not in a retirement plan) assets, and access to a much wider investment universe are benefits of regular investing versus an annuity.
She is concerned about negative media. She believes everyone is expecting a market correction. I responded that if most people are bearish, then that would be baked into prices already, reducing the risk of a correction. Negative sentiment is healthy. Exuberance is dangerous. Markets are counter-intuitive, which explains why emotional investing is a bad idea.
As reference, the above chart illustrates a popular, low-cost balanced fund (the blue, top line). The 2000 – 2002 correction barely registers as a dip with the balanced fund. The blue line shows that a 3 to 5-year reserve fund would have been sufficient to avoid selling at a loss during the 2008-2009 crisis. The fund’s performance suggests that concerns referencing the last 2 major bear markets are more about the unknown than they are grounded in fact. This is not unlike children being afraid of the monster under the bed.
The orange line below the blue line represents the S&P 500. Investing in only the S&P 500 is not a good idea, but that seems to be the straw man argument many insurance companies use to sell annuities.
Finally, consider the commission. How much is it and where does it come from? This is not alchemy.
Past performance is not a guarantee of future results. Investing involves the risk of principal. The chart illustrates the performance of a popular balanced fund from January, 1999 to April 27, 2015. The fund may hold up to a 75% equity allocation. The chart is intended to illustrate the performance of a diversified portfolio relative to the S&P 500 during the 2000 – 2002 and 2008 – 2009 bear markets. Diversification does not guarantee against loss. The balanced fund is the Dodge and Cox Balanced Fund, and the data is from Morningstar.