Paul Winkler: Welcome to “The Investor Coaching Show.” I am Paul Winkler. We talk about money, investing, financial planning, retirement planning, news of the day — whatever happens to be something, whatever comes out. It’s just kind of the way this works.
Question About Annuities
So there are a couple of things that I want to start with in this particular hour. There was a question that came in from a previous show.
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So the question was regarding a previous segment that I had done and it was about annuities, and I have from time to time talked about that. Sometimes what happens is people say, “You always hate these things” And I go, “Well, it’s a tool.”
It’s like saying I always hate flathead screwdrivers. Now let’s face it, we don’t use a flathead screwdriver as much as we do a Phillips-head, but it doesn’t mean that I hate them when it comes down to it. If I need a flathead, that is going to be what I need and a Phillips-head isn’t going to cut it when I’m dealing with a flathead screw, right?
Well, it’s the same thing with annuities. There are certain things that they do that are just a job that in some cases can be really, really handy.
So the question says, “Mr. Winkler” — I always kiddingly say that was my dad. I’m Paul. — “I very much enjoy listening to your shows. I’ve gained some very helpful information regarding personal finances and benefited our family as well as those I’ve been entrusted to help.”
Thank you for that. That’s great.
The Math Around Annuities
He said, “Recently, the ‘I hate annuities’ broadcast caught my attention.” Now what I was quoting there was Ken Fisher, who does a lot of advertising.
He has these things where he says “I hate annuities.” And he was being picked on because it was just a blanket statement and kind of like I said, sometimes there are cases that they make sense.
I don’t sell them, we don’t do anything, so we don’t sell them. We don’t have a dog in the fight. But I talked a little bit about that.
He said, “Well, that broadcast caught my attention.” He said, in all capital letters, “I, like Mr. Fisher, hate annuities.”
“Your justifications of sometimes they’re okay, just didn’t make sense.” He said, “Therefore, I’m seeking to understand your example of investing $50,000.” That number came from someone who, I don’t know if he’s president, but he’s higher up in this college that teaches financial planning topics. This $50,000 example came from that person, not me.
“The example of investing $50,000 in getting an IRR” — which is internal rate of return — “of over 8% doesn’t add up. If an 85-year-old granny put $50,000 in and three years later she dies, at $5,000 a year she received $15,000 in income, but lost $35,000 of her money to the insurance company.”
Now number one, that 8%, I actually pointed out in my segment that the number was wrong. And the reason I said the number was wrong, is because it was correct based on the numbers given in the example, but I actually ran the numbers with a broker that deals with a lot of different insurance companies and said, “If you had a 65-year-old woman and she gave you $50,000, how much income would you get?” And as I recall, it was like $300 a month, which was well less than the $5,000, and the internal rate of return dropped to like 5% as I recall, or something like that.
It was much lower. So that’s the internal rate of return if you live to life expectancy. That’s if you are 65 and you live for another 22 years or something like that, as I recall the number was.
So if you gave me $50,000, and as an insurance company you got paid 5 grand per year, rounding, then at the end of 22 years you’ve got $5,000 times 22 years. And so you’ve got over $100,000. You gave them 50, and you got over $100,000 in the internal rate of return.
You look at that and go, “Oh, well, the reality of it is I had to live the entire life expectancy to get that internal rate of return.” Now I argue that the internal rate of return was likely to be lower because when running quotes from other insurance companies at this point in time, I couldn’t find anybody that paid that much. So you can argue those numbers. But in essence, you have to live the entire life expectancy.
Your example here in the question is that three years later she dies, then you’ve only gotten three payments of $5,000 or $15,000. Yes, correct. You’re absolutely right.
And that is why most people won’t annuitize because they think, Well what if I die? What if I don’t live all the way to life expectancy?
You can’t even say I had an internal rate of return; I lost money.
That’s absolutely correct. So I agree with you.
Why People Invest in Insurance
And he said, “Who in their right mind would want an insurance company beneficiary of their hard-earned savings?” Well, who would? And that would be the example I gave in the segment of a lady in her 80s who had a five-year life expectancy. The situation was that in her case, if she handed the money to an insurance company the payout was actually much higher.
It was not quite 20% of her money each year. So if you give $100,000, maybe the payment was 17 grand per year, and my memory’s fuzzy about the lady that I was talking about in the example. But it was a situation where I had a lady that had a five-year life expectancy and if she gave the insurance company $100,000, they were going to pay her $17,000 per year. Well, if you look at it, if she lived five years, she lost a little bit.
But remember, an insurance company’s got to make money. The reason was that they had a guarantee payment.
But here’s the situation. If she lived way beyond her life expectancy, she won big time. The worry in this particular case was that she said, “I have $100,000, and if I try to pay myself an income every year and I miscalculate and I live too long, I run out of money, which is a terrible scenario. So I’m going to transfer the risk that I live too long to an insurance company.”
That’s why people might do it. Now, most people don’t do it because of the reason you’re saying.
If you don’t live long enough, you’ve just basically handed all your money to the insurance company. And that’s what insurance is.
When you buy auto insurance, you pay your auto insurance every single year and if you don’t have a car accident, you’re not liable for anything. You don’t have a situation where the insurance company has to pay out because you’ve smashed your car up or you smashed somebody else’s car up or you’ve damaged somebody else’s property — that money’s gone.
And basically, you would say the same thing. “I’ve handed my hard-earned money over to an insurance company.” Well, that’s what insurance is.
In health insurance, it’s healthy people paying for sick people. In auto insurance it’s people that drive poorly getting paid or getting payment by people who drove well and didn’t have any accidents or didn’t have any calamity or people who just didn’t get unlucky. You might just get unlucky and have a big claim because the roof crashes in on your house because there’s some weather-related event or something like that.
It’s just the unfortunate getting paid by the fortunate that didn’t have a claim, if you look at it that way. Now you could turn it around and say you’re pretty fortunate if you got paid when a calamity happened. You’re fortunate that other people paid who didn’t have a calamity, so the insurance company had money to make you whole. Just a different way of looking at it.
Annuities vs. Life Insurance
He said, “So annuities are a whole life insurance of investing. The insurance company and the agents selling them are the biggest winners and the consumers are grossly taken advantage of. Fear sells.” Now, annuities are different from life insurance.
A whole life insurance is where you’re overpaying so that you have a level premium throughout your entire life.
Think of life insurance as if you have term insurance. This 20-year term, you’re going to have a level premium for 20 years, but you don’t build up any cash. Then at the end of 20 years, the premium shoots up, but you’re probably going to drop the insurance after that point. So this is a different deal, really, when it gets down to it.
With life insurance, you’ll have a five-year term where the premium stays level for five years. If you pay a little higher premium, you can buy a 10-year term where the premium remains level for 10 years.
Well, what are you doing with the 10-year term? You’re overpaying in the first five years compared to the five-year term. You’re overpaying. You’re paying too much because you’re planning on keeping it for the next five-year period.
In the five-year term, you’re not planning on keeping the term for any more than five years. So the premium stays level, then it shoots up so it’s lower. And you’ll hear a lot of financial people say, “Oh, you need just 20-year term.”
That just depends on how long you need life insurance for. Because if you buy a 20-year term, but you only need it in coverage for 10 years, you overpaid for the first 10 years with the 20-year term. If you’re going to drop the 20-year term policy, which is where the premium stays level for 20 years, if you’re going to drop it after 10 years, then why would you buy a 20-year term and overpay in that first 10-year period?
Well, if you want life insurance for the whole of your life, then what you’re doing is vastly overpaying. But you’re doing it because later on when you’re 60 years old, you’re not going to be able to afford term insurance anymore because it would skyrocket in price. So you’re overpaying in the early years for those years later on when you don’t want to be paying an exorbitant premium for insurance like you would with term insurance.
Now here’s the reality: Most people don’t or won’t want life insurance in their 60s and 70s because life insurance is to cover your income and you at work. So what you’re doing is you’re buying insurance. So if you stop working early prematurely because you died, your family has something because you weren’t able to work until you were 65 or 70 or whatever you were going to plan on working to.
So what you do is you pay a premium for something that if you stop working, that machine in the back room of your house — which is you creating income, creating money — if that machine breaks, it stops creating income, then you’ve got something to replace that income. That’s kind of like ensuring a machine that creates money. That’s what I like to use as an example of what life insurance is.
And the reason that insurance agents love to sell this stuff is because the premiums are a lot higher and the commission is based on the premium. See, you’re right about that. For a lot of people, whole life insurance doesn’t make a whole lot of sense.
Buying From A-Plus Companies
He gave an example. He said, “Years ago, my wife and I were sold six whole life policies by a mutual benefit life insurance agent, from a reputable A-plus insurance company. After 11 years of doing business with them, we were educated in how to buy low cost term insurance and invest in good quality mutual funds by a fairly new company.”
And that is literally what most often makes more sense: to buy term insurance, a much lower premium, and put money in your 401(k) or your 404(b) or your retirement plans or some other place. The difference between the higher whole-life premium and the lower term insurance premium frees up money for investing. Yeah, exactly.
“Two years after making the change against the advice of the agent, the MBLIC went insolvent.” How about that? And that’s a funny point that he’s making right there. The insurance company he bought the whole life from, they went insolvent, is what he’s saying here.
“Boy, I would’ve been investing in an insolvent insurance company.” I agree. Yeah.
You hear these people say, “Hey, buy from an A-plus-rated company.” Well, it’s A-plus-rated when you buy the insurance or the annuity or the life insurance policy.
That’s why I don’t like it as an investment, or any of these things as an investment. Because what you’re doing is you’re betting on that insurance company being around.
All the insurance company is is an intermediary between you and where your money ultimately gets invested.
We can bypass them. But he says, “How about that? We decided to do business with a fly by night company at a cost of 70% of what we were paying.” So A-plus companies do go out of business and that’s exactly right.
Fortunately, the legal reserve contracts are usually taken over by another insurance company. That is correct. Typically, if you invest with an insurance company and they’re licensed in a state and they go under, other companies in the state take over their business.
What Insurance Companies Invest In
Here’s the situation that you can run into: The contracts aren’t the same that you had with the previous insurer. I’ve had that happen before.
But here’s the thing when I talk about this: What the insurance companies invest in are all very similar investments. If the investments are all similar between all the insurance companies, and some calamity happens and those investments don’t work out, and all the insurance companies are investing in them, who is going to take over who?
Who’s going to take over whom or whatever the proper English is? Who’s going to make you whole if all insurance companies are negatively affected by it?
You look at what insurance companies invest in. I’ve talked about this before. It’s a lot of bonds.
A lot of the insurance companies I’ve talked about are actually getting into higher-risk investments to try to get higher yields right now.
And they’re competing like crazy with each other. If that puts them all on a little bit shaky ground, and you’ve gone and invested all your money in these annuities and insurance companies, you could have a problem on your hands.
So yeah, it’s A-plus-rated when you invest in it, but then down the road, they start investing in things that are more speculative. There was one article I talked about not too long ago that talked about how these insurance companies that are issuing these annuities have like 30% of their money in more speculative investments. And you go, “That could be a problem down the road.”
I’ve talked about some of the investments that they’re getting into. With some of the corporate bonds that they’re getting into, those types of things — what if you have high duration like the banks did, high duration bonds, and interest rates shoot up? That could be a problem.
No-Load Annuities
So he said, “I’d be interested to know more about the no-load annuities I mentioned.” He said, “And for information purposes only, because I still hate annuities.”
There are situations like this, and here’s where the no-loads come in. You’ll have some insurance companies issue no-load annuities, with no commissions on them. You can have a situation where somebody against maybe better judgment bought an annuity and they put $100,000 into it 30 years ago, and maybe they’re sitting on a $150,000 gain. Maybe they made less than they should have because it was a bad annuity, but they make a lot of money if you yank that money out.
So I’ve got $100,000 that went in and it grew by $150,000. So you have $250,000 of the value of the annuity and you’re just using it as an accumulation vehicle. You start taking money out of that thing and it’s last in, first out.
So in other words, you have to burn through the $150,000 of gain in order to get your principal back — the $100,000 that you put in. And it’s all taxable. Ouch. That can be a problem.
So what do you do? In those situations, you might do something called the 1035 exchange. So you take the $250,000 and you move it to a no-load annuity, so there’s no commission, so you don’t get a hit and they don’t take away a bunch of your money and send it off as a commission to the advisor.
But then you can use what’s called a variable annuity for a very low cost. Some of them have mortality expense charges that are non-existent. Some of them literally get rid of M&E (mortality and expense) expenses after 10 years.
And they may be like 0.25%. I mean, super, super low for the first 10 years because insurance companies have to get paid.
But you’re looking at it and going, why would I do that? Why would I pay 0.25%? To avoid the taxation on the $150,000 a gain. It could push you in a really high tax bracket and you could have a lot of that $150,000, when you yank that money out, go straight to the federal government.
Now you haven’t paid an insurance company, but you pay the federal government upwards of 37%, even higher if you’re in a tax state of your money. And you’re going, “Wow, dang, that much of my money has gone out the door to a government. That really stinks.”
So it’s like, “What do I do?” Well, I can actually move to a no-load annuity and do it that way.
So in those cases — Richard, thanks for your question — Richard, that’s why you might use an annuity. I hope that’s clear. I hope it’s clear.
If there are any other questions that come up as a result of it, just send us a message. But I hope that makes that clear.
Yes, in general, a lot of times annuities don’t make a whole lot of sense. Yes, they are a commission.
They’re just a big commission driver and they create a lot of income for the agents and the insurance companies.
Many times they don’t make sense. But there are situations where they do.
I don’t go and say, “Paint everything with this brush and say it’s never a good idea.” Just recognize that a lot of times, it’s not. And the more you know and understand this stuff, the less you’re likely to be taken advantage of.
The Truth About EVs
I’m on a roll. Another question came in. If you’ve got a question for me and you want to run it by me, go to paulwinkler.com/question.
There are a couple of ways to make sure that you hear the answer to your question. We can send it to you and we try our best to make sure that we do that.
Another thing is to make sure you subscribe to the podcast because then you’ll see your question come up and go, “Oh, there’s my question,” and you automatically get a notification that we’ve done a segment and an email about that will let you know that that’s happened. So you can do that as well. And you go to paulwinkler.com to do that.
The question that Gene asked was this: “Hey, Paul, any thoughts on this from an investment standpoint?” And the headline of the article he was talking about was, “The Ugly Truth About EVs’ $10 Trillion Fatal Flaw. Here’s How You Can Get Rich From It.” The article talks about what you deserve to know about the truth about the electric vehicle industry and why the CEO of Jeep confessed that unless this fatal flaw is fixed, the market will collapse.
With the EV market, I’m assuming that he’s talking about the stock market. Because if you think about it, there are car companies out there that have not gone the EV route, or they’ve gone the hybrid route, which has been a lot more popular – more about that in a second. Or other companies will come out with something totally different that people would like more if that particular market collapses and nobody wants it, if nobody does anything with EVs or they stay with gas engines.
So like a lot of us, I’m going, “Yeah, I’m sticking with my gas engine for a while.” That’s just me.
I just look at it and go, “I can’t put myself in that position. I don’t trust the technology yet. It’s not where I want it to be.”
Personally, that’s where I am.
Profiting From Companies Failing
Anyway, it says, “Click here to see under the hood of the EV’s fatal flaw and how you can profit from it.”
So a lot of times the way people try to profit is they try to predict that technology is going to totally collapse.
And as a result of that technology just falling apart, the companies that actually have followed that technology will be greatly harmed by making the move into that area.
Now, one example of that would be, I remember hearing GM talking about how they had gone hog wild into EVs. Not like Toyota, which said, “I think hybrid is kind of where we’re going to go,” they went all EV.
Now, there have been news stories recently where GM is backpedaling, from what I have seen. They’ve been backpedaling on this, and they had gone all in. And now they’re seeing that going all EV battery has been a mistake.
Now they’re going “We need to watch out and look at how we have made this decision, and maybe we need to do something different. Maybe we need to go the hybrid route more than what we’ve been doing.”
And here’s what happens. People try to use this information to pick the stocks or pick the companies that they think are going to do well and get away from the ones that aren’t going to do well. Well, this is all based on the assumption that the market doesn’t see what they see.
For example, let’s say that you had a company that got involved in the technology in their industry and it was a bad move. As an investor who was thinking about buying stock in that company, if you saw that about the company you were thinking about buying — you were going to go, “I think I might buy them,” you would go, “Well, why would you buy them if they took on a technology that was bad?”
Well, because maybe the company figured out that it was not a good idea to go down that road and they decided to do something different. And maybe they’re going to do very good in the future because they’ve got a lot of resources that they can employ to actually go the new direction and maybe change their ways and they will actually do just fine in the future, but maybe they had a misstep in their past. Everybody’s entitled to a few mistakes in their life, right?
And then they go, “Hey, you know what? I’ve changed, I’m repentant. I’m not going to do that anymore.” And maybe they’re a good bet going forward, and maybe that’s why somebody would choose them, but there’s risk and maybe there are some problems.
Expected Earnings Yield
So what would an investor do if they’re looking at a company that hasn’t done so well and they’ve made a few missteps? They would pay less for it.
Less based on what? Based on earnings that are expected.
So if you’re an investor and you’re thinking about investing in a company like GM that went all in on EVs and that was a mistake, now you’re asking, what would be the price compared to the earnings? What would you expect the price to be? You’d expect it to be low.
Based on just when this question came in the day, this question came in earlier this week, what was GM’s stock selling for? Answer: $5.37 for every dollar of earnings, of what expected earnings are.
So how many years would it take you to totally get back all your money based on earnings? Answer: five years.
What’s the earnings yield? One divided by five, which is 20%. It’s a pretty high earnings yield.
You look at that and go, “Wow, that’s a really low price, and that earnings yield is pretty high. Why would anybody give up a stock?”
Let’s put it another way. That has an earnings yield that’s 20% because the earnings may not continue to come in. There is a risk. That’s why the stock’s selling for so low — only $5 for every dollar of earnings — because there’s a risk that the earnings won’t continue to come in.
Okay, what about Toyota, which did not go all in on EVs? What is that company selling for? Double — $10.49 — which is still low, but Japan has had problems of its own. And the whole EV, even the hybrid has been a bit of an issue.
What do stocks normally sell for? About $16. But basically, what I want you to get here is that GM is selling for one-half of what Toyota is. Presumably probably a big part of it is because they jumped on a technology that wasn’t ready for prime time, whereas Toyota did not do that.
Gambling on Stocks
So can I profit? Well, I’ve got a hope that maybe I can short GM stock. I’m thinking, Well, gosh, how much lower can it go?
You’ve got to hope that things get even worse for them than they are right now. They may get way better because they’ve seen the light.
Or I can profit, I think, by buying a company like Toyota that didn’t make the same mistake. Well, I’ve got to hope that things get even better because that price is higher.
So you’re gambling when you try to pick these companies based on thinking that they’re mispriced, that GM is selling for too high based on what it’s really worth, or that Toyota is selling for too low based on what it’s really worth. And you’re betting against other people who know as much, if not more than you. That is a gamble.
So when I see this kind of stuff about how you can get rich, you’re making the assumption that you know something that nobody else knows. If that were the case, you would find that active managers had performance that was higher than everybody else out there.
And what do we know? 93% of professional managers investing large cap mutual funds underperformed the market over 15 years according to DALBAR or according to research from SPIVA, and it’s like 96% of small-cap managers fail to match market returns.
The likelihood that you know something that nobody else does is not great.
This is something that just gets you to speculate and gamble with your money — these types of newsletters, this type of information. If they really knew how to get rich from this information, why would they give it to you?
The answer is they wouldn’t. They would keep it to themselves.
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.
