Thursday, January 5, 2012

Get A Clue

    One of the things that frustrates me the most is when I read an article or headline in the financial media that clearly shows a lack of knowledge about the product or issue being discussed.  I see it often and it is a major problem.  The problem is, many investment journalists have no clue about what investors want and why they want it, and people that create investment product never sit down to look an investor in the eyes who may buy the product they created.  In December, I came across the following headline:
    “U.S. insurer's sales of variable annuities (VAs) rose 16% (y-o-y) to $40.2 billion in Q3'11 despite an increase in volatility in the equities markets, according to LIMRA. It was the sixth consecutive quarter of positive sales growth, with the last three posting double-digit gains. Year-to-date, VA sales are up 18% to $120.9 billion. Fixed annuity sales declined by 1% to $61.9 billion over the same span. Sales aren't as robust due to the low interest rate climate. Demand for guaranteed lifetime income is fueling sales.”
When I saw this headline my first response was a chuckle and then I said to myself, “Get a clue.”  I then called a few friends of mine that are financial advisors and shared the headline with them and they all laughed as well.  What we were all amused by was the term “despite”.  Using the term “despite” implies that people that buy variable annuities do so because they are looking for long-term growth in the stock market.  In some cases that may be true but let me share with you how variable annuities are sold, why they are sold and to whom they are sold.
    The article would have been accurate if it said “because of volatility in the equity markets”.  Investors that have an ability to build a portfolio that is properly positioned to build long-term wealth do not buy annuities.  Investors that are seeking or talked into buying variable annuities are scared to death and have usually had a very negative past investment experience.  I am 37 years old and my 3 investment models have 10 year average annual returns of 8.83%, 9.60% and 10.53%.  Do you think I am ever going to feel the need to pay ridiculously large premiums and annual charges to insure my portfolio?  The answer is no.  I do not need to insure something that does not need to be insured.
    Investors that purchase variable annuities are the ones who are emotional, and the ones that need the feeling of safety.  Some financial advisors prey on this type of investor and sell variable annuities while others use the variable annuity as a measure of last resort.  Sometimes the only way to get the client to properly position themselves for long-term growth is to offer the possibility with an insurance security blanket wrapped around the portfolio.  Is it a very expensive option?  Yes, but sometimes it is the only option to get investors to do the right thing.  I've seen advisors banging their heads trying to get a client to invest in a balanced mutual fund portfolio without any success.  When those same advisors went back to the client with the same suggested portfolio design but with an expensive insurance option attached, the clients then agreed.
    I contend that if investors would just take the time to educate themselves and learn how to properly invest then they would not feel the need to insure a portfolio.  A properly designed portfolio does not need to be insured and does not carry the high costs of premiums, riders, mortality and expense charges and administrative costs.  Not to mention possible surrender charges and the costs of the fund managers charges within the sub-accounts.  With so many hands dipping into variable annuity investors pockets, how in the world do they expect to get ahead?  Depending on the amount of riders variable annuity investors decide to add to their policy the total cost of annual ownership could be more than 3% a year.  It does not have to be that way.  
    So let’s be clear.  Variable annuities are not bought by investors and sold by advisors “despite” volatility in the equity markets.  Variable annuities are bought and sold “because of” volatility in the equity markets.  Yes some advisors recklessly sell variable annuities to everyone, but often times the annuity is the only way to get the investor to show some resemblance of doing the right thing.
It’s like Chris Farley’s character said in the movie Tommy Boy:
“Hey, if you want me to take a dump in a box and mark it guaranteed, I will. I got spare time. But for now, for your customer's sake, for your daughter's sake, ya might wanna think about buying a quality product from me.”
If you have a quality portfolio in place it does not need to be guaranteed!

Jon R. Orcutt, founder of Allocation For Life, is an asset allocation strategist and author of “Master the Markets with Mutual Funds: A Common Sense Guide To Investing Success”