I’ve been hearing commercials lately for financial people selling products that guarantee a 7% rate of return and can’t help but think that many consumers are getting taken in by the claims. If you listen closely to the ads, they claim the guarantee is “for income purposes”. What does that mean?
The simplest way to answer is to explain that the 7% figure is an illusion. The insurance company maintains a separate ledger for the actual investments and the “income rider”. If the investments fail, then they will base your income off of the account that supposedly grew at 7% per year.
Why do I say “supposedly”? It is because the insurance company is in complete control of the income they will pay you. As I pointed out in a video on my website showing an actual case, the income ends up being a fraction of what it would be if the actual investments earned 7%. In other words, it’s an illusion that has been used very successfully in selling these products to an unwary public.
To keep this even simpler, consider this point. Investing is all about paying you to use your money. The less risk there is, the less that the borrower has to pay. The lowest risk borrowers are always banks and the government. Insurance companies are fairly low risk as well. With this in mind, an insurance company whose leaders would choose to borrow your money at 7% would have to be woefully ignorant; especially considering that banks and the government are able to get by with paying only 1% to, at most, 3% to use your money.
If such a deal truly existed, I and every other academic educated on investment matters would quickly climb aboard. Foreign governments who own US government bonds would also likely follow suit. Why put up with close to zero percent returns when there is a free lunch on the table?
One of the challenges in warning investors about these annuities is the wide range of variations in product design. Once the consuming public becomes wise to a negative feature of the product, the insurance industry is quick to eliminate the offending attribute. However, they just end up shifting the problem to another area and the product survives to fight another day.
In short, risk is a part of living. If I avoid risk in one area, I will unwittingly take risk someplace else. History has shown us that investor’s instincts and emotions are their own worst enemy and, often, the investment industry is only too willing to profit by playing to those emotions whether they be fear, greed or any other driver of human behavior.
