I remember September 1981 vividly, but not for reasons you might think.
Young, bulletproof, and fearless, I “met the Stones” and, much to my parent’s chagrin, nearly got arrested in the process, which is a story for another time.
That got me thinking.
The 1981 tour to promote Tattoo You, the Rolling Stone latest album back then, was widely expected at the time to be the last time the Rolling Stones went on tour. Yet, 38-odd years later, I find myself getting ready to buy another round of tickets to see Mick and the boys do their thing.
Only this time, like the band, I’m a little greyer and a whole lot older.
Back then, the concert tour was sponsored by Jovan Musk which had paid $1 million+ for the privilege of having their name printed on tickets and being able to create and sell their own Stones tour poster at fragrance counters; it was all about optimism and energy. This time around the tour is being brought to you by the Alliance for Lifetime Income, an annuity provider and the tour is all about longevity.
Unfortunately, annuities can be one of the single worst investments you ever make. The fees are outrageous, the documents complicated, and the agents who sell them… well, let’s just say that many are ethically challenged when it comes to high-pressure sales tactics and leave it at that.
The concept of having a lifetime of income, however, is more important than ever.
The Rolling Stones first stepped on stage at the Marquee Club in London in 1962. According to a handwritten set list I found on udiscovermusic.com, the band played songs from Fats Domino, Chuck Berry, Jimmy Reed, and more.
Every $10,000 invested back then would be worth $256,020 now using the S&P 500 as a proxy. Of course, you’d have to put up with a lot of volatility over the years.
Fast forward to 1995.
That’s when a bunch of insurance wizards from the Keyport Life Insurance Company debuted a product called equity-indexed annuities promising a set minimum income level or rate of return plus the ability to capture market gains without the risk of losing money.
The idea is easy to understand and alluring.
You invest a lump sum for a fixed-time period – often 10 years or more – and in return receive a guaranteed minimum rate of return, plus the market upside, with none of the losses if it goes down.
If the market to which an EIA is indexed – like the S&P 500 – rises by more than the minimum promised return, your money is supposed to grow proportionately. In exchange for making the investment, the insurance company offering the EIA guarantees that your money will never drop in value.
The devil, as they say, is in the details.
In reality, the paperwork that explains equity-indexed annuities is some of the toughest financial legalese of all to decipher and understand. Not only are the sales documents filled with complicated language, but assuming you can get through the 40 to 60 pages of stuff that comes with an EIA, chances are you’ll find a wide range of conditions, restrictions, and terms that frequently change over time. There are guaranteed minimums, performance adjustments, participation rates, interest-rate caps, and spreads to contend with, for instance. And that’s just for starters.
In addition, many EIA’s also cap the returns you can achieve no matter how far the markets rise, which would seem to defeat the purpose of investing in one of these things in the first place. More often than not, that you and your money will be left in the dust if the markets really take off.
To put this into context, if you invest in an EIA with a performance cap of 10% and the markets actually rise 20%, you’ll leave over 50% of possible gains in the insurance company’s pockets…not yours.
Then there are the associated fees and charges, which are quite hefty. In fact, various studies suggest that the purchase of an annuity typically results in a wealth transfer of as much as 15% to 20% from the investors who buy them to the insurance companies and the sales forces who sell them. That’s something not a lot of folks realize when they consider purchasing one of these specialized investments.
Despite these shortcomings, sales of EIAs are growing again just like they do every time fear rears its ugly head. According to Investment News, index annuity sales are projected to grow nearly 40% by 2023 to roughly $96 billion.
Worse still, no two products are alike which makes apples-to-apples comparisons practically impossible. And, of course, the insurance industry likes it that way.
The bottom line on EIAs is that the returns you think you’ll be getting if the markets rise may be nothing more than an illusion once all the contractual details are netted out. They’re basically being sold as alternatives to stocks, when the reality is that they’re much more of a bond-related instrument.
I’ve never been a fan but then, again, I’ve always known something the insurance industry doesn’t want you to know.
A dirty little secret really.
You can construct your own equity indexed annuity for a fraction of the cost. No complicated paperwork needed, no pesky sales calls, no hard to understand legalese.
Here’s what you’ll need to know if the notion of a guaranteed income and all the profit potential you can handle tickles your fancy.
First, visit Discover.com (or your local bank). As I write this, the company was offering Federal Deposit Insurance Corp. (FDIC) insured seven-year CD paying 3.05% APY through Discover Financial Services (NYSE:DFS). Assuming you’ve got $20,000 to invest, you’ll need to plop down ~$16,206.68 now to have $20,000 in seven years. (You can run whatever numbers you want using financial calculators available on the Internet).
Second, take the remaining $3,793.32, and buy the SPY exchange-traded fund (ETF), which tracks the S&P 500.
That’s it. No extravagant fees. No surrender charges. And, most importantly, no upside-performance caps.
Plus, your investment is now guaranteed by the FDIC, which strikes me as a whole lot safer than a comparable EIA which, incidentally, is only as good as the insurance company backing it.
Worst case scenario, you get your $20,000 back in seven years. Best case, if stocks recover from here, and achieve 7% annually for the next seven years, you’ll earn an additional $9,367.58, making your grand total $29,367.58.
What’s more, because there’s no complicated contract involved, you will understand what you’re getting into from the get go, and will get to keep 100% of the potential gains to boot.
In closing, it’s worth noting that EIAs are frequently touted as tax-advantaged investments in an attempt to make them more appealing. But if you simply buy the CD and the SPY in your IRA, you’re achieving the much the same thing – but without the 9% commission.
As Jagger would no doubt croon… and did back in 1981 when the song by the same name was released “Start me up!”…
See ya at the show!
Until next time,
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