Equity Indexed
Annuities (EIAs) have become the hot product of late. I
believe you can easily find other alternatives that will
bring a better return, without locking up your money or
levying hefty surrender penalties. I’ll discuss these
alternatives in the next two articles. But first, you should
understand two things: your purpose for investing and how
EIAs work.
Know why you’re investing. For simplicity let’s consider two
objectives—stability and growth. If you are primarily
concerned about protecting your investment and earning a
stable rate of return then your main objective is stability.
On the other hand, if you are concerned about protecting
yourself from rising prices, building a retirement nest egg
or growing your wealth then your primary objective is
growth.
It’s unlikely that your objective will be 100% stability or
100% growth. Usually it will be a combination of the two.
For instance, if you’re 55 years of age and preparing for
retirement, perhaps you’d want about 40% of your portfolio
invested in ‘stable’ investments such as bonds or CDs, and
60% invested in equities such as stock mutual funds.
On the other hand if you’re 75, stability may be more of an
issue for you. You still want to plan for inflation, but
your objective is very different from a 55 year-old. You
might have 70% in stable investments and only 30% of your
money in equities.
Maybe you’ve been told EIAs are the perfect answer. They’re
sold as delivering both stability and growth. Salespeople
say you can participate in the growth of the stock market
without the risk, while always earning a minimum of 3%. It
seems that an EIA will help you meet both objectives. Upon
closer examination, though, you will see that it doesn’t do
either very well.
EIAs are said to provide stability because they provide a
minimum return of 3%. Let’s put that in perspective. In
return for that 3% minimum you are required to keep YOUR
money in the investment for many years, or else pay a
penalty that in some cases could be the equivalent of over 3
years worth of return!
Moreover, that 3% minimum doesn’t change over the long
length of the investment. If interest rates increase during
those 7 to 12 years, you will be unable to take advantage of
them. Imagine how you would feel if you knew you could be
earning 5% or 7% in a CD or government-guaranteed bond, but
you were stuck in an EIA paying 3%! The stability an EIA
provides just doesn’t measure up.
So let’s take a closer look at the growth offered by an EIA.
Typically, your investment choices are limited to the S&P
500, NASDAQ, or a bond-related index. But EIAs place a limit
on how much you earn. If these indexes go up 25% or 50% like
they did in 2003, you may only earn 10% to 12 %.
EIAs only allow you to only participate in a portion of the
index’s return, or they have internal charges of 1-2%. Even
if the underlying index goes up 10%, your return will be
lower. This makes sense when you realize the insurance has
to earn back the enormous commission it paid the agent. The
insurance company can’t pay a 3% minimum in the bad times
AND allow you to get 100% of the return in the good times.
So, in an EIA, you bear the risk of investing in the
stock market but don’t get all the return. Don’t stack the
deck against yourself. When you invest in equities you
should have access to thousands of choices, and get all the
return.
The bottom line: why trap yourself in an investment that
greatly limits your upside potential and shackles you with
outrageous surrender penalties, all for a measly 3% promised
return, while your agent walks away with a 10 or 12%
commission? No matter how you need to split your portfolio
between stability and growth, believe me, there are much
better ways to manage your money. I’ll talk about them next
week.
If you have a specific question or would like more
information, give me a call toll-free at 1-877-827-1463 or
go to www.guardingyourwealth.com. You can also reach me by
email at jeff@guardingyourwealth.com. I will be happy to
help you in any way I can.
Mr. Voudrie is a Certified Financial Planner and the
President of Legacy Planning Group, Inc., a Private Wealth
Management firm in Johnson City, TN. |
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