* Company risk. All too often, investors who buy any kind of annuity invest far too large a slice of their total wealth, increasing the risk of losing principal or potential returns if the insurance company founders. Many used to consider this risk to be minimal before the problems of AIG, the insurance behemoth that nearly foundered in the financial crisis of 2008-09 under the weight of worthless derivatives before the U.S. government bailed it out.
Then there are VAs’ relatively low returns. Various studies have shown that direct investment in stocks tends to deliver far higher returns without any of the other downsides.
A good way to beat VA returns with low long-term risk is to invest in stocks that regularly pay dividends. These regular payments to stockholders -- paid by mature, low-risk companies based on earnings -- account for more than 40 percent of total market returns over the past 80 years, with dividends from the S&P 500 outpacing inflation by 100 percent. Since 2010, annual S&P 500 dividends have been eight times annual inflation. As many companies are sitting on significant amounts of cash they aren’t using because of sustained low consumer demand, dividends are expected to increase nearly 10 percent this year. In effect, instead of investing this money in increased production, they’re paying some of it out to shareholders. By contrast, many VAs are sold with an effective guaranteed minimum return of 5 percent.
Of course, it’s easy to make this kind of minimal guarantee when the insurance company is investing your money in the market for long time periods, because over decades, it’s highly unlikely that diversified stock portfolios will lose money, either. So the real issue is: How much is an annuity going to cost you in terms of missed opportunities to invest a huge tranche of your wealth elsewhere? After all, we’re talking about decades, not years.
These guaranteed rates are based on market performance. The problem is that there’s often a reset on the measurement of market performance every quarter, which over time can slice into your returns. Years-long rolling measurement periods would usually mean much higher contingent returns.
So, in return for this guarantee, investors are actually paying quite a bit. (This is consistent with the reality that whenever there’s a guarantee, there’s usually a cost involved.)
What’s more, the rate guarantees usually only last until you either die or annuitize — that is, convert the assets of your annuity into a series of regular payments. Fewer than 1 percent of all annuities are annuitized.
And many are eventually folded into — what else? — a new annuity with a new commission that investors again indirectly pay for. Salespeople tend to call about the time the penalty period on the existing VA expires.
This call would be your opportunity to make the same mistake a second time by buying another annuity. You can avoid this by not getting a VA in the first place.
Dave Sheaff Gilreath is a founding principal of Sheaff Brock Investment Advisors LLC. He has more than 30 years of experience in the financial services industry, beginning with Bache Halsey Stuart Shields and later Morgan Stanley/Dean Witter. At Sheaff Brock, he shares responsibility for setting investment policy, asset allocation and security selection for the company's managed accounts. He also consults with the clients on portfolio construction. Gilreath received his Certified Financial Planner® (CFP) designation in 1984. He attended Miami University in Oxford, Ohio, where he earned a B.S. degree.
Any opinions expressed are solely those of the author and not of ABC News.