Paul Winkler: Welcome to “The Investor Coaching Show.” Paul Winkler here, talking about the world of money and investing.
Whatever happens to be in the news — there’ll be something I might be talking about. What I think might be on your minds, the things that I’ll be talking about will typically be driven by that, because a lot of times we think about things based on what we’re seeing in the news, and it brings up questions.
Finding Investing Information
One of the things I saw this week — let me preface it with my view on where we get information about investing.
Most of us get information about investing. Some of us may turn to the financial channels. And of course, you’ll have the talking heads out there, and you go, “Okay, what’s their bias?”
Well, who do they want to interview? They’re going to want to interview CEOs of companies. You had a lot of that with Davos. There are a lot of people talking about Davos — conspiracies about it and so on and so forth.
I am not going to necessarily get into that. But the thing that you’re doing is you’re talking or hearing from somebody who would love for you to buy their stock or to create demand for their stock.
Because if they can create demand for their stock, they can drive the company price up, or they can keep people off of their back.
If they’re talking about their company, and they’re the leader of the company, and they would like to keep their job — maybe if they are able to talk about what their strategy is for running the company —- then they can get people to not necessarily get on their back about how they’re running the company. There’s a lot of talk about Disney in that particular vein, as a matter of fact, this week.
Another place you might get information is from a mutual fund manager who’s being interviewed or maybe an investment person.
Back in the day, you would have a lot of these organizations that put out magazines. They would call me and they would say, “Hey, what do you think? We want you to come on our show.”
And I’d go, “Oh, great. Yeah, really? Wow.” And you find out that you have to pay to be on their show and you go, “Oh, wait a minute.”
Wading Through Investing Information
So basically your article in your tabloid or in your magazine or whatever is just paid advertising for the investing industry. “Oh, okay. I kind of see how this stuff works.” There are some things that I had done where I had a PR person who would just put me on a TV program, but a lot of times, you’d have these TV programs where you have to pay to get on there.
So it’s credibility for the investment advisor to get on TV and not necessarily what it appears to be. But it can be worth it if you have a message that’s out there and you want to get out there.
The way radio works a lot of the time is that you have paid advertisements and you hear who the show’s brought to you by, and then you have the ability to sell advertising inside of the slot. That’s how I started, actually. I actually had people that would sponsor the show.
I had dentists, I had a CPA, I had a home decorator, an interior designer, a restaurant — I had a lot of people that actually sponsored this show. It’s how it got started. I was very, very thankful to these people. But that’s how that works.
But what happens is we’re getting information from people selling us something quite often, and that is why I got away from the sales side of things. So here, what we do as a registered investment advisor that takes absolutely no commissions whatsoever is we don’t have any investment providers in between.
So when I’m giving information, it is based on my research and based on my beliefs and what I believe to be true.
I always got my information, but I would second guess it and go, “Well, is this really accurate? Where’s the information coming from? Does it make logical sense to me?”
And that was a big thing: Does it make logical sense? Like for example, when Eugene Fama, a University of Chicago professor, was talking about and teaching the Gordon growth formula and cost of capital and looking at PE ratios and where returns came from, I was able to go, “Okay, I can put one and one together and it does equal two. It makes sense what this guy is saying.”
So the information that we’re getting from the industry, being the sales side of things, can be a little bit hard to wade through.
The Problem With Annuities
Well, Ken Fisher is one of these guys who is an RIA. Full disclosure, we don’t use any of his services whatsoever because I just don’t believe in what he does or how he operates. So I’ve never chosen to sign up and work with them at all.
But he has this thing about annuities that he puts out there. And he has actually coined this term, “I hate annuities.” He has actually registered the trademark, “I hate annuities.” So if you’re going out there and doing a search for something, you may see one of the ads pop up.
Especially if you’re searching for annuities, you’ll see, bam, “I hate annuities.” Well, I like academics when it comes to getting information because, typically, they don’t have a dog in the fight. But here is an exception. And I’m not going to talk about who this is or anything that is pitching a fit about Ken Fisher’s stance on annuities.
But I just want to point out that sometimes you’ll have colleges actually run by insurance people and you go, “Okay, what are they they going to recommend? What do they think is a good idea?” Well, typically, they’re going to think insurance is a good idea, and annuities being an insurance product, are a good idea.
And it’s not that they’re always a bad idea, but sometimes what’ll happen is insurance people will go, “Hey, look at this academic. This professor thinks that insurance is good or that annuities are good. You ought to think that annuities are good.”
Now, I am in the middle. There are times when annuities do make sense. Some people will say, “Well, Winkler always hates them. He never has anything good to say about them.”
I think they’re a product that is overused and oversold out there because of the level of commissions that are typically paid on these products.
That is the problem that I have with it.
The Concept of an Annuity
I don’t have a problem with the concept of an annuity. The concept of an annuity is you put money in, and you have a certain life expectancy, and they’re going to spread the money out over your life expectancy.
A pure annuity would be that if you get paid for one year, but you have a 20-year life expectancy and you die after one year, the money’s gone because they’re taking the risk that you might be living for 30 years past your life expectancy. So that’s the idea behind it.
Well, the RIA famously argues that anything that can be done with annuities can be done better with other investment products.
And then it says from an academic perspective, total refusal to recommend an annuity is not in the best interest of retirees. That’s the stance of this person, this academic who works for the company that actually is owned, or run by, excuse me, an insurance company.
The guy used to be the CEO of one of the big insurance companies. Now an article says, “Ken Fisher has mounted one of the most successful attacks on a single financial product in history. Consumers searching for annuities have seen ads explaining earnestly why retirees shouldn’t buy them. He’s even registered the trademark ‘I hate annuities.’”
It’s no secret that he doesn’t like them. He says they’re a source of many consumer complaints. And the insurance industry has generally done a remarkable job of creating an opening for someone like Fisher to capitalize on negative product perceptions as an honest alternative for retirees or investors seeking retirement advice.
On his site, he notes that he doesn’t sell annuities. Never has, never will. Why? He says he’s fond of saying that he hates them because he believes anything you can do with an annuity can be better done with other investment vehicles.
Now, I would generally disagree with that, that you can’t do what an annuity does because an annuity is an insurance contract.
Investing in an Annuity
So I’ve had situations, and one I like to give as an example was a guy who came to me one day and said, “I’ve got a mom. She has a limited amount of money left. She has very, very little left.”
She only had like a hundred thousand as I recall or something like that. “She’s 86 years old. Paul, what do you think I ought to do?”
It would’ve been incredibly negligent on my part to say, “Hey, let’s go and invest it,” because the reality is I don’t know how much longer she’s going to live. She doesn’t know how much longer she’s going to live. Nobody knows how much longer she’s going to live. And what happens is, let’s say if you’re that age and you have a five-year life expectancy, then the insurance company likely only needs to spread payments out over a five-year period.
Now there’s a possibility they might have to go 10, 15 years. She might live to 96, she might live to 101, we don’t know. But let’s say that her life expectancy is five years. There are some people her age who are going to be gone a year from then.
Now, in her case, if she lives longer, the people who did the same thing that she did — buying an annuity and spreading it out over the rest of her life — the people who died early would be subsidizing her because maybe they only got a payment for one year and they had a five-year life expectancy — that leaves four more years of payments to go to her if she lives four years past life expectancy. Very, very much simplifying, but I hope you get the idea here.
So what happened in that particular case is that when I explained to her, “The money’s gone when you’re gone,” she was like, “Ah, I don’t like that.” And I said, “Well, you can do a certain period, five years certain, which is where literally they’re going to pay you for life if you’re around for 20 years. But if you’re only around for two years, they’re going to pay your family an additional three years. So they’re going to make certain that there are going to be five years of payments that come out.
“Now, how do they do that? Well, they reduce the payment. There are 100 pennies in the dollar. They’re going to have to reduce the payment, and that’s exactly what they do.”
So what happens with the contract here is that in this particular case, it just goes for however long she goes, and then if she’s gone, it’s gone.
Now in this particular case, this writer, this academic, is writing about what the benefits are of this. And the benefits, he’s right about — you have retirement income for life as long as you’re around.
When Annuities Look Compelling
Now, one of the things that he makes a point about in this article is how profoundly confused they are that people don’t actually annuitize. They don’t actually like to take this income for life.
They don’t like to take the risk that they could be disinheriting their children and their grandchildren. They don’t like losing control.
And they’re like, “Well, why? I can’t believe this. It makes no sense.”
Now, the point that I want to take issue with in this particular article is the number that he uses at the end of the article because this is what his whole premise is based on. And you may have an investment person, an annuity salesperson out there using an article such as this to say, “Hey, look, even academics believe that this product is always great. It could be really great for you.”
Not always great, but it could be great for you. He says, “Can a fiduciary” — that’s somebody who has to keep your best interests first, and I’m paraphrasing what he is saying here — “with good conscience tell a 65-year-old to liquidate a product, get rid of it, let’s say with a $50,000 contract value?”
So you stuck $50,000 in the contract, in the annuity, that would have paid a $5,000 lifetime income benefit. So with $5,000 and 10% of the account value, you look at that and go, “Wow, that’s 10%. You can get that every year.”
And if you’re around for 50 years, wow, it’s huge. Think about it: You get all your money back in 10 years. And this is a 65-year-old, who would quite likely be around for more than age 75.
So you think about it, he’s making this point, and you go, “Wow, that really does seem pretty compelling, doesn’t it?” There’s this healthy 65-year-old woman who has enough wealth to meet the Fisher minimum and can expect on average to live to age 89. So you look at it, they’re probably going to live past the age of 75 that he’s talking about here.
The internal rate of return on a policy liquidated for $50,000 to 65 would be 8.8%.
Checking the Math
So I checked the math. I went to my little calculator and I checked the math, and indeed, he was correct that that was the internal rate of return.
But like I said, I don’t just stop there. I like to go a little bit beyond and check the math on things because I don’t necessarily trust anybody — whether they say that they’re a professor or not or whatever, I just don’t trust.
So I actually went and got a quote on a 65-year-old woman. What I found with the top payment is even if you said, “No, I am going to go for broke. I’m going to do it for life, and if I die in one year, the money’s gone. I don’t care.”
I didn’t do the five-year certain that I talked about a little bit earlier. The payment was $307 per month. Well, you do the math on that, that’s quite a bit less than the 5,000 per year, right? It’s a little bit over $3,600 per year.
That’s a pretty big cry from the amount that he was saying that you would get. The internal rate of return drops down to 5.3%. Now, not bad, right?
Not bad, but think about this: When you are in a period of very high inflation or higher than usual inflation, interest rates are higher because that’s how interest rates work. There’s a very high correlation between the two, number one.
Number two, even with interest rates being high, are they that high? Because you look at 10-year treasuries and you’re looking at about 4%, so this is actually higher than the 4%. And we’re not even assuming that the insurance company has to make a profit.
So the question you should be asking yourself is this: Where are they getting the return to be able to give you a 5% return?
And you get down to it and say, “Well, where are they getting it?”
Hidden Risks to Annuities
Well, there was an article written, as a matter of fact, a little bit back, on an annuity website. If you look, well, where would you not expect an article like this? An annuity website. But this article is actually on an annuity website, annuity.org, and it’s called “Is There Hidden Risk in Your Annuity Company’s Balance Sheet?”
And they talk about the level of bonds — that about 62% of investments sold or held by US insurers are bonds. What risks do the bonds hold or what can they hold? Well, reinvestment risk.
What if when those bonds mature, they go and invest that money at lower interest rates, but they basically promised you a high interest rate like that? Let’s say if interest rates come down, then what happens to the insurance company? Now they’ve got a problem. If interest rates come down like that and they reinvest the money at lower interest rates, they’ve got an issue on their hands.
What are some of the other things? We look at that and we go, “Well, they’re investing in something else.” What else could they be investing in? Well, corporates.
What is the problem with corporates?
Well, what if corporations go bankrupt and they can’t repay their debt? That’s a default risk that you’re dealing with with bonds.
So you’ve got reinvestment. And what if interest rates go up? Then you’ve got another problem on your hands. For example, you had Silicon Valley Bank where all of a sudden interest rates went up and all of a sudden bond prices went down, putting the bank at risk.
So anytime you see somebody paying a little bit higher than market interest rate or assuming a higher than market interest rate, you’re thinking that they’ve got to get a profit in there, that they somehow have to be earning higher interest rates on the money in order to pay the person and the interest rate that I said is built into that product. Because I used the life expectancy that this professor used in the article, age 89.
And that’s what the internal rate of return came out at for a 65-year-old female using a Tennessee insurance company. I used Tennessee as the state of issue. So you look at that and go, “Well, wait a minute, this could be an issue, right?”
Annuities as Accumulation Vehicles
So recognize that there are times when insurance company products like annuities do something that nothing else will do, but recognize that quite often they are being used as accumulation vehicles, not as distribution vehicles, much to the chagrin of this particular academic who can’t figure this out.
“Why would nobody do this? I can’t believe that they wouldn’t give up the right to their money and hand it over to the insurance company and disinherit their kids or lose control of the ability to actually pull more money out than the insurance company’s going to send them. What if I have a big hit and I need a bunch more money and I want to go and pull more money out? I can’t figure out why they would not like the idea that they’ve got this annuity product that pays them the same income every year.”
And I use the example of going back to the 1970s. A $7,000 to $10,000 income was all you needed as a family to be just fine. Today, try to live on $7,000 to $10,000. It’s not going to happen.
With an annuity, what you’re doing is you’re getting that same payment every single year with a regular fixed annuity. You’re getting that same payment unless you have cost of living riding into it. And if you do, then the payment’s way less than what I just gave you right there.
Payments are way lower than that because they’ve got to build in for themselves the ability to increase your payment in the future.
They will start at a much lower level than $307 per month, as the example that I gave.
Now, if you missed some of these numbers because you just tuned in, go back and listen to the podcast, paulwinkler.com. Check out the podcast because this is important stuff to get. Quite often what happens is we’ll hear things like this, and we don’t know the numbers behind it, and I feel it is my duty to make you a more informed investor. And I take it seriously.
Part 2
Paul Winkler: We’re back here on “The Investor Coaching Show.” I say “we” because look who the cat drug in: Mr. Ira Work.
IW: Well, I was in the neighborhood and thought, “Yeah, why not stop in for a little bit?”
PW: Yeah, man.
IW: Not sure how long I’ll stay.
PW: Well that’s okay. You don’t have to stay long.
Insurance Companies and Risk
PW: I don’t know if you heard what I was just talking about.
IW: What was that?
PW: I was talking a little about publications and, you know, how we’re very much into academic research.
IW: Absolutely.
PW: Well a person from a college was talking about how Ken Fisher is all washed up regarding his “I hate annuities” stance. You find ads all over the place and he does a lot of TV advertising as well.
But he has this big thing, “I hate annuities,” and people accuse us of saying we hate him, too. No, it’s just that it’s a tool. Sometimes tools make sense, and sometimes they don’t make sense, is kind of our stance on it.
But in this particular instance, he gave an illustration number. He said, “You have a 65-year-old woman, $50,000 and the insurance company’s going to pay $5,000.” If you’re a fiduciary, you’d be hard-pressed because the internal rate of return on a $5,000 payment is about 8%.
Now, if those numbers were indeed correct, I would say yeah, you would be hard-pressed in some instances. Because let’s say if all the person wanted was a guaranteed income and they weren’t concerned about inflation at all and weren’t concerned about giving up access to their money or the control or anything like that, there may be a case that doesn’t make sense.
But I ran the numbers on immediateannuities.com. There is a website where you can actually run numbers to see how much income an insurance company has, and they shop between several different companies to see who would pay the most amount of income.
And the number came back completely different. $307 per month was the number, which is an internal rate of return that was much lower, more like 5%. Now, this is fairly high if you look at government bonds rate at 4%. My point that I made was this:
How does an insurance company that has to make a profit pay you more unless they’re taking more risks than just buying the bonds?
And I pointed out that yes, insurance companies do take more risks, and I talked about corporate bonds and the issues and reinvestment risk and things like that. So anyway, you’re up to speed now.
Guaranteed Income
IW: All right, well, let’s break things down. Number one, with the insurance companies, some of the people are not going to live to take all their money out of the annuity. And when you do an immediate annuity, if let’s say you put in $50,000 and you’ve only gotten $25,000 in income, the insurance company keeps your other $25,000.
They know based on the statistics of people living and dying approximately how much of that they’re going to keep. So as a result of that, they contend to make the return a little bit higher than a government bond.
Secondly, the insurance company —
PW: No, no, wait, hang on a second. When they’re paying this money, if this person dies early, it’s got to go to the person that lives longer. So therefore what happens is they’re not going to make a profit on just people who die earlier unless they make mortality assumptions that are shorter. Or longer, excuse me.
IW: Well, it’s all going to depend because there are a lot of different ways to structure the annuity. So for example, most of the people that I’ve done immediate annuities with are people who are not concerned about leaving money to beneficiaries. There tend to be more single people and they just want the maximum amount of money they can get for their lifestyle.
PW: What age typically for you?
IW: Usually it’s in their 70s or older.
PW: That was another point that I made: The only time that I have recommended it is when people are much more advanced age, even in their 80s. Up to the point where you have to watch this — sometimes an insurance company won’t issue a contract at all depending on how old the person is. But that’s a point that I made as well.
IW: Right.
The other thing to realize is insurance companies are not using insurance products to guarantee income to people who buy the insurance products.
PW: Yes.
IW: They’re investing in stocks and fixed income, government securities and mostly corporate bonds because of the guarantees. It’s no different than what we recommend based upon the academic principles that tend to lean toward Nobel Prize-winning academics.
PW: Except that the insurance companies don’t typically have much, if anything, in equities. So they’re not using the multifactor type stuff that we talk about here on this show, but they are using a lot of bonds. 62% was the number for how much they have in bonds.
They typically have a lot of real estate is another thing you’ll see in the portfolios. But to give you that rate of return you would have to be taking — and it’s the internal rate of return that he was talking about here in this article — over 8%.
There’s nothing out there that’s paying 8% with any kind of safety. So if the internal rate of return is that high, there’s no such thing as a free lunch is the point that I was making. And as this one article points out, there’s a lot of risk in the insurance companies and the annuities company, in the balance sheets of these companies.
IW: Well, that could be based upon and depending upon the insurance company. So an insurance company that has a lower rating — a more risky insurance company — will provide a return a little bit higher than you can get from a more highly rated insurance company because that lower-rate insurance company just wants to get more money. Therefore, you’re taking more risk.
Why Annuities Are Sold
PW: Are you ready for this, Ira? You’ve been doing this for how long now?
IW: March will be 40 years.
PW: Okay. Have you ever seen an insurance company that had an A+ rating or a very high rating when they issued products end up with a downgrade in the rating?
IW: Well, I remember Executive Life.
PW: That was really baiting you. I know you remember.
IW: Yeah. I remember.
PW: I know you do.
IW: I remember Executive Life, which was an A-rated company that actually filed for bankruptcy.
PW: Wasn’t it A+?
IW: It could have been A+.
PW: It could have been; I don’t remember. But yes, exactly.
IW: But it was one of the more better-rated companies.
PW: Yeah. So the issue that you run into is that you could go out there and comb the ratings websites to make sure that you have a highly rated insurance company, only to have the insurance company invest in things later on after your contract is issued that stink. And then all of a sudden the company gets taken down and the rating goes down but you already own the product.
IW: Yeah. The real reason why annuities are sold, in my opinion, is twofold. One of them is the high commissions that they pay. And number two is agents can use the term guaranteed.
PW: Exactly. Exactly.
Well, I might as well talk about this because it happens to be something I found. So you have this article in Yahoo Finance, “8 Reasons Annuities Might Actually Be a Bad Investment For You.” You might want to just comment on a few of these as I go through that.
IW: Sure.
PW: I wasn’t planning on doing this, but why not? A woman receiving the terms of her annuity paid $1 million upfront and received $5,000 a month after retiring. Simple, right?
Unfortunately, annuities are rife with complexities and prevent a clear understanding of their benefits and potential pitfalls.
Now I’m just going to hit the negatives in here. The positive is reliable, long-lasting income.
Now the question is, will that income have the purchasing power? That’s number one that you have to think about. You have some tax advantages.
IW: Okay.
The Impact of Inflation on Annuities
PW: And then there are tax disadvantages. You want to go through this?
IW: All right, so on the income that you can outlive, that is all well and good, providing that we don’t go into a period like we just had over the last year-and-a-half to two years, where inflation numbers really increased the cost of your goods and services and the products that you’re going to buy.
PW: I mean, yeah, that is a huge issue.
IW: So yes, so if you sign up and you get that immediate annuity and it’s giving you $400 every month for the rest of your life, yes, if you live another 100 years, you’re going to get $400 a month for the rest of your life — the next 100 years.
However, if the goods and services you’re buying for that $400 go up to $600, $700 or $800, well now you can only buy half of that amount of food.
PW: Oh, there was a guy pitching a fit. It was a funny video on one of the streaming services. I don’t even know what.
But it was this guy’s pitching a fit. “This is how much I’m paying for gas and this is how much I’m paying for food.” Did you see that video?
IW: I saw that. Yes, I did.
PW: Yeah. What did you think?
IW: I thought it was amazing.
PW: He was having an absolute —
IW: Meltdown. He did it in his car.
PW: Yes. Yes, you did see that video.
IW: Yeah.
PW: Okay, so yeah, you’re that person, and let’s say you’re getting that income, and all of a sudden, gas prices are going up, your food bill is going up, your gas that you heat your house with, or electric that you heat your house with, is going up, your phone bill is going up, a new technology comes out that you want and now you can’t afford it because you’re on that fixed income and the value of that paycheck is going down every single month due to inflation. What’s your recourse?
Setting Income Based on Fixed Expenses
PW: What they’ll do in the sales process is say, “Well, you don’t do it with all your money. You look at your fixed expenses and you set your income based on your fixed expenses.” What’s wrong with that Ira?
IW:
The problem with that is you might need all the assets that you have to help you manage and you’re not going to get any growth on any of those assets.
PW: Okay, so I’m going to bait you on this one. What fixed expense do you have that you have had throughout your however many years that you’ve owned a home? I don’t want to be that specific.
What fixed expense do you have that doesn’t go up at all? Name all the fixed expenses that you have that don’t go up at all over the past 20 years.
IW: There’s only one fixed expense that I have that has never increased and that’s my mortgage.
PW: Thank you. Exactly. The insurance costs go up, the taxes go up.
IW: Oh, my taxes.
PW: Your expenses for your TV and your cable bill go up, your insurance costs go up on your automobile, on your homeowner’s insurance.
IW: Everything.
PW: What doesn’t go up?
IW: Nothing. Everything goes up.
PW: You nailed it.
IW: Except for the mortgage.
PW: The mortgage. That was it. And do you still have a mortgage, typically? Hopefully not when you’re in retirement. So the one thing that would’ve stayed a fixed expense is gone because you paid off the mortgage
IW: Unless you were silly and you bought one of those adjustable rate mortgages and you still have a mortgage and then interest rates go up.
PW: Ouch.
IW: Then your mortgage payment does go up in retirement.
PW: Yeah, just the thought of that is no fun.
IW: No.
PW: Yeah. So I look at that and go, man, their whole premise is blown up.
Tax Advantages
PW: So let me hit the rest of this. Tax advantages. That’s a double-edged sword because you have tax deferral on the interest.
IW: Okay, so one of the questions that I get is this: What can I do to reduce my taxes? And the only real answer to that question is to make less money. That is it.
So yes, you can put money into a product like an annuity or your IRA account, into a diversified portfolio for your IRA. You can reduce your current taxes on the income that you currently have, or you can reduce the taxes or completely eliminate taxes on the growth of your annuity or your IRA or your 401(k), until the time comes when you’re taking the money out to live on. Because there are two phases. There’s the accumulation.
PW: That’s the problem. When we talk about tax advantages, they start to look really bad. Yeah, go ahead.
IW: I’m just getting there. So there are two phases.
There’s the accumulation phase and then there’s the de-accumulation phase when you’re beginning to live off the money you’ve accumulated.
Well if taxes go up — as can possibly happen in 2025 because of the tax cut, and those are going to sunset in 2025, so we’re going to see taxes go up — now you’re taking money out of those deferred annuities or your IRA or your 401(k), and you’re paying higher taxes on that same money.
PW: And it’s last in, first out with the annuities. So you put $100,000 in, it grows to 175 and then you start to pull money out. Let’s say you don’t annuitize because you’re going, “I don’t want to lose control of my money.” Now you’ve got to burn through that $75,000 of gain before you get your principal back.
Now that’s really what we’re dealing with here. So that’s one thing.
Fighting Inflation
PW: The other thing is you talk about fighting inflation.
That’s the problem with fighting inflation: You don’t have that protection.
Another point that they made was that annuities can be incomprehensible.
IW: All right, well let’s go back for a minute to fighting inflation. I’ve had a few, maybe three, four clients call me and say, “Why should I stay in this portfolio when I can take my money, put it into a CD and get a guaranteed 5%?”
Well, there are two problems with that. Number one, that certificate of depression is what you’re going to feel when you realize you’re only getting 5, but inflation’s now 7, 8, 9%. And depending upon what you’re really buying, some of the prices of food, inflation has grown up 25 and 30%. So you’re getting five, but you’re actually losing money to inflation.
PW: You can have issues with inflation. I think about when you talk about food prices — why are they going up? Well, one of the reasons is you can have wars that actually cut off the distribution of certain food products from countries that produce a lot of that particular food product. Can we say Ukraine and grain?
IW: Right.
PW: You look at that and that has nothing to do with monetary policy as much as it has to do with geopolitical risk. There are a lot of things that can come up that you don’t even think about.
So that’s one thing right there: product flexibility. They come in — various types of these products can be fixed, variable indexed or a combination of the two — and then the thing that you can run into is you might have inflexibility, which is a liquidity issue. If you need more money than what they’re going to be paying you every month, let’s say you annuitized it —
IW: But there’s another problem. When you put that money into that, let’s say 5% CD, then the Fed begins to lower interest rates and banks begin to lower interest rates.
Reinvestment Risk
IW: The problem that you’re going to have is what we call, or what is known as, reinvestment risk.
PW: I mentioned that a little bit earlier before you got here.
IW: All right, great. So when you have, let’s call it that $500,000 that you just locked up in that CD at 5%, and you’re getting $25,000, and you need that to live on to pay all your fixed expenses plus the ones that do go up, like your gas payments, insurance payments and so forth.
But now the interest rate didn’t go down that much. Let’s say it only went down 1%, so now it’s 4, and instead of $25,000, you’re getting $20,000. Meanwhile, a lot of the people who have cash sitting on the side are now realizing they can’t get much money in fixed-income investments. They push that money back into the stock market, driving the stock market further up.
PW: Yes, you’re so right. Yes, I was going to go there if you didn’t.
IW: And then you begin to draw money off of an asset that actually increased in value.
PW: Or before you were in it.
IW: And you miss out on that gain as well.
PW: That is absolutely brilliant and exactly right. Because what happens quite often when interest rates go down is we see stock prices jump in anticipation that interest rates are going to go down.
We saw that in the last quarter of last year. The thinking was that interest rates were going to go down and then you had this huge appreciation in stocks in anticipation that that was going to happen. You don’t even have to wait for it to happen and it happens.
IW: Well, the problem is that everything we’re doing is waiting. We’re waiting for interest rates to go down. We’re waiting for the stock market to up because the reason we’re waiting is we have no control. The only control that we really have is to diversify the portfolio and rebalance, and that helps manage the risk of the portfolio and it helps get higher rates of return.
But inflation is an animal that I’ve watched for 40 years now and there’s just no way around it.
You just need to invest in a way that will keep up or hopefully outproduce inflation long term.
PW: Exactly.
When Annuities Make Sense
PW: We just happened to hit this thing. The annuities and the eight reasons they might be a really bad investment for you.
Another one that they gave in the article as a reason it might be a really bad investment for you is burdensome fees. And the insurance company’s going to have to make money. But not only the insurance company is having to make money. Who else?
IW: The agent.
PW: That’s right. You have to pay the commissions. You have to pay maybe renewals or whatever.
IW: And that’s why there’s a surrender charge. Look, when we’re talking about, “We hate annuities,” we don’t really hate annuities.
PW: No, you can’t say that. That’s Ken Fisher’s line.
IW: All right?
PW: We don’t hate them.
IW: But here’s the thing: We actually have annuities available.
PW: Yes.
IW: And there’s really only one time when we use them.
PW: No load annuities.
IW: Well, that’s the type of annuity that we have, that we work with.
PW: No commissions that means.
IW: No load. More importantly, no surrender charges. You want to get your money out of it a week later — let’s say 45, 50, 60 days later — because most annuities have either a 15 or a 30-day free look where you get your contract and you get to read the contract, if you’re going to understand the contract, and you come to the conclusion that this is not —
PW: You’re a rocket scientist.
IW: — that this is not something that you really want to stay in. The company will send your money wherever you want them to send it. So, if you decide 60 days, 80 days, 100 days later after the annuities that we do work with, that it doesn’t work for you, there is no surrender charge.
Most contracts that I’ve looked at, they’re going to lose 12.5% if you get your money out in the first year. So, when they say your principal is guaranteed, yeah, it’s guaranteed as long as you keep it in there for 12 years, or seven years, whatever it might be.
PW: Right.
IW: But the time that we do recommend the annuity is simply this. If you’ve invested, let’s say $50,000 in a non-qualified or a non-IRA type of annuity, not a retirement, a lot of advisors out there are recommending you roll your 401(k) over into an annuity and it’s under an IRA program.
So, if you went to an advisor and said, “I really don’t want to pay taxes; what can we do?” and you take $100,000 and throw it into a non-retirement type of annuity to protect it — because they sold your own fear, you can’t lose your money, they sold you on greed — you can get the returns of the market.
PW: As long as it’s based on the insurance company’s strength, yes. You have to throw that in there.
IW: So, when you’ve invested in a non-retirement annuity, it grows from 50 to 100.
We’ll use an annuity so you don’t have to pay the taxes pulling that money out, but you get the diversified portfolio.
PW: Yeah, and then we call it 1035 exchange. So, yes, there have been instances. So, if anybody says, “Well, Winkler and those guys don’t ever do it,” that’s not true. There are times when annuities do make sense.
Advisory services offered through Paul Winkler, Inc an SEC registered investment advisor. The opinions voiced and information provided in this material are for general informational purposes only and not intended to provide specific advice or recommendations for any individual. To determine what investments are appropriate for you, please consult with a financial advisor. PWI does not provide tax or legal advice. Please consult your tax or legal advisor regarding your particular situation.
