Paul Winkler: Welcome, this is “The Investor Coaching Show,” and I am Paul Winkler, talking money and investing and educating as we go. There’s something I want to talk about for just the first part of this hour.
Conversations With Financial Advisors
Now, I’ve said many times that I came from the insurance industry, from working for a big insurance company. Of course, we had a broker-dealer where you could do securities, you could do mutual funds, you could do stocks, you could do bonds, and we used to trade stocks and bonds and things like that. That’s one of the things that we had in our arsenal. I did everything.
We literally had property and casualty, homeowners, and auto insurance. We had disability insurance, long-term care. We had everything.
So it was great because I had so much experience with so many different areas that I could tell you a lot about because I got licenses in all of them. And as time went on, I was just like, “I’m not going to do this anymore. I’m not going to sell this stuff anymore.” So I got out of those types of things.
But I’ll have conversations with people and financial advisors and a lot of times, I like to talk to people and say, “Hey, what are you doing? Have you considered doing this a little differently?”
I remember years and years ago talking to a guy at a big convention where the guy had a booth set up and was working for this investment firm. I said, “So, what do you do? What are you doing? How are you doing?”
He started talking about financial planning, and I said, “So what degrees have you picked up?” And he goes, “Well, no, we don’t have that,” and I was asking about various degrees and he said, “No.”
And I said, “Why don’t you consider going and doing that?” He was a young guy.
I’m thinking, Why don’t you consider going and actually getting a financial planning degree, and then you start with a charter financial consultant or a certified financial planner and then you move from there and you build on that? That’s my philosophy. You don’t just leave it there. You continue on beyond that.
But he hadn’t even gotten the first one. And he said, “We’re just trailer park financial planners.” I was like, “Oh man, you are doing such a disservice to your clients and they don’t know that you don’t know these things.”
“They don’t know what you don’t know” is kind of the way I like to put it. So I have conversations from time to time.
I hear people talk about products as if a product is a solution to all your retirement planning.
And a lot of times, insurance companies will approach things like that. “The product is the solution. You get income from this product and when you retire, you just put all your money in.” And I’m thinking, Would I want all my money with one insurance company?
And I was like, “No way. I used to work for insurance. I know what’s going on there. I don’t want anything to do with this.”
Sequence of Returns Risk
So there was a product that was brought to my attention and I thought I would just review some of the things in here because this is the stuff that people don’t realize is going on. And the product was a nationwide product. It was called New Heights.
They have what’s called indexed universal life, and then they have indexed annuities. I couldn’t find anything on the indexed universal life product that was being talked about, but I did find something on the product with the same name under the annuity. And I thought it would be instructive just to walk through what is actually happening and where people get misled regarding these products.
If you know anybody who’s using these types of things and working with an advisor who sold them something like this, here is the sales pitch. Let me tell you really quickly because you got to get that this is how it’s approached.
“We’re going to give you returns. We’re going to give you market-like returns.”
The review was done by a financial firm with a couple of guys, one was an attorney and a certified financial planner, and the other one was a CFP, and it was put on the National Association of Insurance Commissioners website. So these are regulators. And I was surprised that they actually had this particular article on the commissioners because these are people that the state regulators go to look at what they have to say about these types of things.
So I thought, This is super, super interesting. But the article is entitled “All That Glitters is Not Gold,” and it’s a review of Nationwide’s New Heights 8 Fixed Indexed Annuity.
So here is what they start off with. They say, “Hey, who wouldn’t want an investment that gives you market-like returns? You can get some market returns, and even better — where you have consistency in the returns — no downside risk.”
So what you’re dealing with is what is called the sequence of returns risk. I have two investments that have the same exact long-term return.
Let’s say that in the first few years, the one investment goes down in value, then it goes way up later on, and then the first investment does that. The second one goes way up first and then it goes down later.
That would be a sequence of returns. The good returns follow the bad returns in one, and then it’s vice versa and the other, right?
And that’s the idea. You go, “Well, gee, you could end up wealthy, fabulously wealthy, with a scenario early in retirement if it goes way up and then it only goes down later just before you’re about to leave this world.” That is optimal.
But if it goes down first, then you could run out of money before the upside happens. And that’s where the problem comes in. So if it goes down, you’re selling shares and selling shares at lower and lower prices. And then finally when you have no money left, it finally goes up and it’s like, “Well, too little, too late.”
Translated by Non-Fiduciaries
So they’re saying, “Who wouldn’t like it if you could just have consistency?” And this is how this stuff is sold. “You can get consistency; you can protect yourself.” It is the marketing pitch contained within the sales brochure on this particular product, the website, and the accompanying video.
So that’s the marketing pitch that you hear. It’s what’s in the brochure, the website, and the video.
And they say, “Okay, here are the things that they’re telling you that this product is going to do.” Tax deferral is number one, so you don’t have to pay taxes on the gains. Number two is the earnings are protected against downside market risk.
And I love the way they put this, kind of smart aleck-y, in the National Association of Insurance, Commissioners: “translated by non-fiduciaries,” meaning in other words, people that don’t have to keep your best interest first.
So the people selling this don’t have to keep your best interest first. Keep that in mind.
What are you willing to say if you don’t have to keep the other person’s interest first? It was translated by non-fiduciaries during the sales process as, “No downside market risk.” Then it says it’s, “an index designed to provide consistent positive returns in both good and bad markets.”
It’s almost like, well, it’s not the same. My mind’s going to Bernie Madoff, right? “You always get a 10% return no matter what the market’s doing.” Yeah, that worked out really well.
It’s not the same, but I’m joking because that’s just the sales pitch. It’s not what actually happens or what even shows up on a statement. But anyway, I got to watch my sense of humor.
“Broad diversification across 15 global asset classes,” sounds good. Diversification is good, right? An index with hypothetical back-tested, average annual return from 1996 within 21 basis points of the S&P 500.
So the returns are very much like large U.S. stocks over that same time period. And more about that in a second because wait until you get into what that really means, what that line means, man. Hypothetical return was 72% less volatility.
Momentum Investment Strategy
They mention the momentum investment strategy. Now, with the idea behind momentum investing as a factor of investing or as what helps returns, the studies actually show that momentum when utilized as an investing strategy doesn’t increase returns because of the expense of employing the strategy.
When something costs too much to do, where it outweighs the benefit, then you don’t do it. You may use it as a way of reducing expenses. And certainly, I am all about that, and there are fund companies that do use it for reducing expenses.
Now, when I say expenses, you can go, “Well, don’t you increase returns when you reduce expenses?” Yes and no. When I try to increase returns above the market and get higher returns than the market using momentum, that’s problematic.
If I am trying to employ an investing strategy, let’s say, where I am trying to look at the S&P 500 — just using that because so many people are familiar with it, the 500 biggest companies — I can’t invest directly in the index. I can’t do that. I have to have a fund that owns the stocks that invest in the index to try to replicate the index.
Now, when I set up a fund to replicate the index, I have expenses because I have to do trading. I have to buy the stocks that are in it, and I have to sell them when they move out, and so on and so forth.
But when I buy and sell those things, I can do things to reduce the expenses of capturing the market returns. Okay?
So when they’re talking about momentum here, they’re talking about increasing returns above an asset class through using this strategy.
So that right there, they talk about that, and I’m like, “Oh gosh, there we go.” “We’re going to try to use momentum as an investment strategy to try to get superior performance,” is what they say here. And the research shows it just doesn’t work.
What’s the Catch?
They said, “No caps on the client’s upside, unlike most fixed index annuities.” That was the other thing that was being talked about by said advisor, is caps.
So a cap is this: If the S&P 500, let’s say it goes up 20% — and it’s not unusual, you’ll have years like that where you have big market returns — we’re going to cap you at 8%. So if it goes up 20, you get 8% of that. For the other 12, you don’t get that return. If the market goes down though, you don’t go down.
And that’s the idea of, “Well, don’t worry about it, at least you’re going to get that upside and blah, blah, blah up to a certain point.” And people, what they do is they hear 8% and they think 8% per year. And they forget that when markets go down, you get nothing.
And then therefore what ends up happening is your return historically ends up at about what bonds would have paid, you see? So that’s why that doesn’t work out terribly well.
But they’re saying, “Hey, no cap. No cap on it.” So you go, “Oh, wow, that sounds really, really good.” More about that in a second, because what’s the catch?
That’s the question we have to ask ourselves as investors: What is the catch?
And when I ask financial advisors those questions, typically they say, “There’s no catch. It’s great, it’s wonderful.”
You start to recognize that the reason they’ve come down to that conclusion is that they have gotten their information from the brochure. They have gotten their information from the insurance company video touting the product and how you sell the product to the public.
And that’s exactly what they said in this National Association of Insurance Commissioners review right here. Basically being a fiduciary, if you’re going to keep people’s best interest first, they said it involves much more than just watching a four-minute video and passing on the wholesaler’s marketing points and graphs to a client.
Because quite frankly, when I was an investment advisor, that’s where we got our information. It was the wholesalers.
They would come in, and their job was to schmooze us. It was the only time I ever went to Ruth’s Chris Steak House in my entire life since it’s been there. The only time I ever went there was when some wholesaler was trying to schmooze me and a colleague to get us to sell their products. So it’s just funny.
Index Options
Anyway, it says, “Neither the advisor, nor the policyholder, are given the pre-purchase benefit of a Securities & Exchange Commission reviewed prospectus.”
I love this line. Let me go through this. “Neither the advisor, nor the policyholder,” so the person selling the product nor the policyholder are given the pre-purchase benefit.
In other words, you can’t read a Securities & Exchange Commission Reviewed Prospectus where the government regulators have looked at the disclosures to determine whether this is something you ought to be saying to the public, neither the advisor nor the client. That to me is insane. And this is what people are buying.
They don’t even know what they’re buying because they don’t get the disclosures until they sign on the dotted line.
And if it’s a life insurance product, you go through the underwriting. You know what would happen when we brought people through underwriting when I sold insurance? You know what they told us to tell the public, the clients?
They told us to tell them that if they signed up for this product, they would get a free physical. No kidding. You get blood drawn, they check it out, and you get a free physical. And that was part of the sales pitch.
Oh, I could tell stories. Doing this for over 30 years, it’s fun for me to tell on the industry. It really is.
So anyway, they say in there that the Nationwide New Heights Fixed Indexed Annuity has several index options the client can choose from including those that track the S&P 500 Index, the MSCI EAFE Index, Europe, Australia, Far East — the Zebra Edge Index is one of the other ones in there. And the guy asked me, “What do you know about these?” And I said, “Oh, yeah, I remember reading about the Zebra Edge Index. I remember reading about that years ago.”
One of my designations was a wealth management certified professional designation. I remember going through and they talked a little bit about it.
And about a lot of the stuff that I’ve gone through from an educational standpoint, I go, “I actually studied under the guy that won the Nobel for Economics. And what he won it for was how markets work and how market pricing works. And I would disagree with some of the designation information because they were trying to tell us everything about how everybody approaches investing.”
And some of it I would just go, “I just don’t agree with that.”
The Zebra Edge Index
But they were really compelling about this one type of index. It was called a Zebra Edge Index, and I remember it was an Ibbotson thing. And when you see the stock market charts, Sinquefield and Ibbotson are the two guys who put the information together from a piece of work called “Stocks, Bonds, Bills, and Inflation.”
So when you see these stock market charts, the data was compiled by these academics. And it’s just a huge amount of data. You just imagine how much data you’ve got to go through to come up with returns of various asset classes going back to the 1920s.
So anyway, what happens is he comes up with this idea that stocks that are thinly traded where there’s not a lot of liquidity, so, therefore, it’s harder to buy and sell the shares because you don’t have a lot of shares trading. His premise was that they should sell at a premium or that they should give us a premium.
In English, what that means is that I should get a return that is higher when investing in these companies because I’m taking the risk of lack of liquidity.
And I was like, “Well, it sort of makes sense, but I don’t necessarily buy this because what’ll happen is all of a sudden, when I know that there’s a premium to be had, then as an investor, I won’t get rid of the stock because I’m going, ‘Well, I’m going to get a higher return if I own this thing, so I’m just going to hang onto it,’ and as a buyer to get that out of the hands of the person that owns it, I’m going to have to offer a higher price, and that will take away the return upside return.”
So I was just reasoning through it and going, “I’m not falling for this one. I’m not buying it.”
Well, it’s interesting. You look at the 15-year return of that index and it’s something like 5% per year; it’s not good. It’s not good at all.
But anyway, that’s one of the indexes that they have in here. And basically what they’re saying here is that the large print on the brochure that the advisor is giving you has all this great stuff, how wonderful it is, and you’re going to get market returns, no downside risk.
But they’re saying here, “Well, you know what? The small print takes it away, just literally takes it all away.”
And they said that interestingly, the brochure has all these attractive features and you can’t get this information, you can only get the negative stuff if you actually sign up for the product or call up the insurance company and say, “You’ve got to send all this information to me before I even do anything,” and you’re going to get reams of paper.
And that’s what they literally said here, the amount of paper on this stuff, on the index, I forgot what it was. They had one index in here, and just to get information on how this thing trades and the different parts of it and what it invests in, it’s 156 pages to describe the strategy.
I’m thinking, Oh my goodness, who is going to read this? Who is going to read that? And what members of the general public are investing in this product, let alone the financial advisors? Remember, they’re not even getting this detailed information because they’re getting the information from the brochures and the videos, and no, nobody’s going to read all that junk.
No Downside Risk
So they’re going through the tax deferral. That claim is true with any of these products, they all have that particular feature. So that particular promise is, “Hey, no big deal, no downside risk.”
And they say, “Well, as is with most index annuities, they have that no downside risk. But the problem is that you do have significant possibilities for downside risk due to back-end surrender penalties.” They said here the carrier could allocate as much as 95% of the client’s funds into a declared rate bucket known as a fixed account with a minimum crediting rate of 0% return.
Well, maybe there’s no downside risk, but that doesn’t seem good. Matt Murphy and I were having a conversation. He said, “Yeah, Paul, I know the best way to get a high return on something or get no risk.” And I said, “Okay, yeah.”
He said, “What’s the lowest risk thing that you can do?” And I said, “Well, treasury bill.” He goes, “Yeah, you know this stuff. I mean from my perspective.”
And I said, “I don’t know. What do you think, Matt?” And he goes, “Bury it in your backyard.” I said, “Yeah, exactly,” except there is the risk that it’ll decay.
But you’re looking at this and going, “I don’t want any downside risk.” And you don’t recognize that with inflation, you basically have just a depreciation in the purchasing power of the dollar, and you’re losing money.
You’re losing money safely. That’s what inflation is. It’s a great way to lose money safely.
And there’s so much here. I’m going to just give a couple of things because I think it’s instructive. You’ve got to hear some of the other features of this thing that you will not hear, and the advisors don’t typically hear about these products. Wait until you hear the minimum guaranteed contract value.
Hypothetical Back-Tested Models
From time to time, I talk to financial people and see what they’re recommending and how they’re recommending it, how they’re selling this stuff to the public. And the product that was talked about was from Nationwide. They have this thing called the New Heights program.
They have an indexed universal life. They’ve got an annuity, index annuity, and the idea behind this is, especially in retirement, you can’t take risk and you want some upside market return, but you can’t take risk. That’s how it’s sold.
So, “We got the product for you, it’s guaranteed you can’t run out of money, you’ll be fine and you’ll be wonderful and everything will be roses. You’ll be walking on the beach with your loved one and you’ll be flying kites,” or whatever. I don’t know.
So they have these indexes inside the indexed annuity, which it is supposed to track like the S&P 500, Europe, Australia, Far East, etc.
Then the other index they have in here, and I talked about it, is the Zebra Index, and that was such a disappointment based on things that I had heard many, many years ago. And what ended up happening was very different from what was promised, let’s just put it that way.
The promise when the index first came out was “The sky’s the limit on returns.” What ended up happening was the ground was more like the limit.
Then they have J.P. Morgan’s Mozaic II Index. I’m like, what the heck is that?
Well, when they wrote this paper for the National Association of Insurance Commissioners, the advisors that actually put this thing together, this research together, they looked at it and they said, “Oh, well, this thing’s only been around for two years. The index has only been around for two years.” It was established on December 28, 2016.
And what is so interesting about this is that they’re saying, “Hey, if you could go back,” and this is a verbatim quote from the National Association of Insurance Commissioners website: “If the investors could go back in a time machine to invest directly in the index, then and only then would the investor have experienced these hypothetical returns.”
Well, that’s great. If you’ve got a time machine, it’s wonderful. But I don’t know anybody that has one of those.
But anyway, it says that, on the other hand, if one could go back in that same time machine to 1996, you could have bought Apple or Google or Microsoft or something else, and maybe you could have done something else that would’ve been as good, if not way better, is really the point they’re making here. Then it says, “Note these types of hypothetical back-tested models are not permitted within sales material when offering SEC-registered securities.”
In other words, you can’t go and say, “Hey, this is what would have done well over the past 10 years, the past 15 years,” and then recommend that to people. You can’t do that. It’s not legal.
But you can do that in the insurance industry and you can go out and sell this stuff to people and lead them to believe that this is what they’re going to experience as well.
Minimum Guaranteed Contract Value
Then, of course, this is sold on the idea that you can’t lose money, right? How about this one: Minimum guaranteed contract value?
It says, “It’s the minimum amount defined by the policy that the contract owner is guaranteed to receive upon surrender.” So if you get rid of this thing, how much is it? Are you going to get back everything you put in plus a big return?
Actually, they said 87.5%. That doesn’t mean you’re getting an 87.5% return. That means you’re going to get about 12.5% less than what you put in.
That’s the minimum guaranteed you’d lose. They’ll guarantee you won’t lose more than that. No kidding, no joke. This is conveniently left out, and this is what they say in this report.
It’s conveniently left out in the illustrations and can only be found in the contract specimen received after purchase, after you’ve already bought the thing. So you’re sitting there with this and you do have 10 days to look it over, but how many people actually read contracts after they get them?
I’ve actually saved some investors in the past. I have saved people from products that they’ve bought because I have gotten them to go and return them and just say no before the ten-day period, but I can count on one hand how many times I’ve gotten there in time. It is a rare thing because most people buy it and that’s it, they just keep it.
They don’t realize until much down the road and after they can’t get out anymore without big penalties that they’ve made a mistake.
Now, it says you have to read the fine print in the contract, and they’re talking about what the fine print is and how these things work, and then they talk about the riders, the expenses of the riders. Then they talk about getting an optional lifetime income rider in here.
So you can guarantee you’re going to get income for the rest of your life and it’s going to be great, right? They can guarantee that.
Fixed Annuities
Well, they give an example in this report on this Nationwide product, that basically says, “Therefore a 60-year-old client who purchases the New Heights 8 Fixed Indexed Annuity policy with the non-bonus version, it says is guaranteed to have $6,295.55 annual income stream for life if the income stream is turned on in the fifth anniversary.” So you look at that and go, is that good? Is that bad?
So I just decided to go and look at just any old yucky annuity, yucky, it’s a technical term, an annuity that pays an income for life, because basically the way an annuity works is you hand a bunch of money to the insurance company and they guarantee that you can’t run out of money by paying you an income for the rest of your life.
Now, if you have a cost of living rider, your income goes way down and you have a whole different problem. But if you look at just a typical fixed annuity, an immediate annuity, you’ve put the money in and immediately they pay an income to you for the rest of your life.
And with the straight version of this, what ends up happening is if you die in a couple of years, the money’s all gone. If you live well beyond your life expectancy, they continue to pay the income until you stop fogging a mirror.
For people that are uninitiated, that sounds good, but the problem is you don’t have cost of living protection in there.
So what happens here? I’ll use an example of a 60-year-old, like they use in this report, purchasing an annuity and getting a guaranteed 1% rate of return.
Because that’s basically what they say here, “On the fifth anniversary, you get a 1% rate of return.” How much money would you have?
Well, you’d have just a little over $100,000. It’s like $101,000, okay? So how much income would you get from this product that they’re saying right here is guaranteed to have a $6,295 annual income for life?
So I ran that against just a regular old product with none of these bells and whistles and all of this garbage in it and regular immediate annuity, and theirs was $7,600, $6,200 versus $7,600. And that’s for a female. For a male, it’s $7,800.
So you look at that and you’re going, “That’s 25% more money. So why is this product so great?”
I’m not exactly sure, and that is exactly the conclusion that these people came to on the Insurance Commissioner’s website. Not so great, but it sounds really good.
“No caps. No caps on your returns, and if the market goes up 20, you get all of the 20%. Now, they do take away the dividends, but big deal. If you’re going to give me all the upside as far as the capital gains go, then yay, this is wonderful.”
Or is it? I believe this is why investors need somebody on their side of the table, somebody to read the fine print and understand the fine print, somebody that is not getting a commission and having that conflict drive the advice that they’re giving.
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.
