Tuesday, August 15, 2006

An old Chinese curse: "May you live in interesting times"

This curse is the dilemma that we live in currently. The go-go days of the 90's are over. We now live under the threat of World War III with Islam. In my humble opinion it has been ongoing in which we are reminded constantly like last week's foiled British airline bombing. What does this have to do w/ investments? America is still living with the mind set of the 1990's. Everyone is living in a dream world where you can get rich quick whether it was the tech boom, housing boom, commodities boom, etc. Folks are spending money way beyond their means and living paycheck to paycheck. The margin for error is getting slimmer by the minute.

An alternative way to invest in these times can be the variable annuity w/ living benefits. The beauty of this investment is that you can invest in mutual funds within the annuity and the insurance company will "insure" your investment. There are essentially two layers of protection that they can give you: Death Benefits & Living Benefits. Death benefits are utilized by those that are looking for estate planning techniques for their heirs. My focus today is on the living benefits that can guarantee a certain rate of return for a specified time. Two riders that can help protect your investment are known as the guaranteed Minimum Income Benefit (GMIB) and the guaranteed Minimum Accumulation Benefit (GMAB). I am going to use the GMIB for an example: John Doe, a 50yr old, puts $100,000 in a Variable Annuity and elects the GMIB rider. The rider in this example will guarantee a rate of return compounded 5% for the next 15yrs. So lets say when Mr. Doe at age 65 decides to retire and his account loses money and is only valued at $80,000, he's screwed right? No because the GMIB account is at $200,000. That's the beauty of this type of investment. If the markets in the future react like they have always done in the past you will never have to use this rider, but it is there for reassurance.

So what's the catch? There are a few of them.
  1. This annuity and rider will cost you 2-4% in fees. Finding one w/ low fees is paramount and these extra fees might be worth letting you sleep easier at night.
  2. The rider's protection will only last for about 10-20yrs or only give you a maximum of 200-300% appreciation. That is why annuities are better for your 45-60yr old demographic.
  3. You must give up liquidity and keep you money with the insurance company. If you leave the company the benefit goes away. People needing the money within 8-10 years should look elsewhere
  4. In order for the benefit to be activated you must annuitize (take distributions) which locks you into the contract permanently.
  5. The guarantee is only as good as the insurance company. If the company goes belly up you may not get that guarantee, so invest in big highly rated companies.
  6. The US stock market has never lost money in any 15 year interval since 1926. Do you really need the protection?

I still believe and invest in capital markets, but for those that are more risk averse and don't want the low returns of cash or CD's this is a viable alternative. Please look at the find print (prospectus) and shop around to interview brokers & advisors. Since there is so much fine print your going to have to really go out on the ledge and trust in who you go with. Use your gut feeling and if they don't mention the downsides runaway! If you have a question feel free to leave a comment about it.

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