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Portfolio > Portfolio Construction

About That Sideways Market...

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Regarding the article, “The Role of Equity-Indexed Annuities” in the August 2006 issue, I would like to bring into question some of the arguments used in support of EIAs and expand on the troubles with the product. It’s my contention that EIAs are not well suited as a substitute for bonds and cash in most portfolios, especially in low-return markets posed in the article.

Mr. Winer’s study comparing EIAs with sideways stock markets is of little relevance to the gist of the article since the study compares EIAs with stock indexes and not the asset classes he is replacing with EIAs, bonds and cash. If Mr. Winer is not using EIAs to replace stocks in preparation for sideways market performance, why cite the supporting study in the article at all?

Regarding the strategy of replacing bonds with EIAs, it should be pointed out that such action results in that portion of the portfolio having a much more direct correlation to the equities portion of the portfolio. This action is likely to make the entire portfolio less efficient. A particularly bad cyclical bear market or, worse yet, a secular bear market could cause extended periods of poor performance for nearly the entire portfolio.

Assuming no significant bear markets, if we have the 6% average market return postulated in the article, factor out non-participation in dividends inherent in EIAs and the target rate of return is around 4% for this portion of the portfolio. This is not a particularly high hurdle for bonds and cash to overcome. There is no conclusive evidence that interest rates are going to raise much above their current levels, and they may just as likely decline. Consider the illiquidity of EIAs due to surrender charge restrictions and the scales can quite easily tip to favor bonds and cash.

This brings me to the last point, an expansion on The Troubles With EIAs portion of the article. Not only did EIAs fall under scrutiny with regulators because of marketing issues but also because of their sheer complexity. EIAs are in no way uniform. Advisors should be very careful evaluating the product. With potential caps on returns, various methods for calculating returns relative to the index, the possibility of less than 100% participation in the index and/or less than 100% return of premium guarantee, and surrender charge periods, there is plenty of room for confusion. So much so, the NASD has issued an investor alert titled Equity Indexed Annuities–A Complex Choice.

Many investors are hard-pressed understanding the inverse relationship between bond values and changes in interest rates. Try getting them to fully understand their newly acquired 10-year equity indexed annuity with a 3% lifetime contract minimum guarantee on 90% of premiums, indexed to the S&P 500 at a 90% participation rate with a 9% cap on a point-to-point reset with a sliding surrender charge and a 10% annual free withdrawal option.

Considering the vast array of EIAs available, it’s difficult to conclude “an” EIA will do anything compared with some other investment option. If we’re going sideways, I’ll stick with recommending bonds and cash and let the investor’s money stay free of surrender charge restrictions.

Jeff Young

Athens, GA

Proper Recognition

I was getting caught up on my professional reading on my trip to London last month. As a member of the board of the Foundation for Financial Planning, I read with interest the good article on “Planning for the Wounded” July 2006 as well as “Catching Up With Ron Kovack” announcing FPA setting up the Hurricane Support Center.

However I was disappointed to see that there was no mention in either article that the money for both efforts came from substantial grants made by the Foundation for Financial Planning. Although we have given grants to the FPA, we are not part of the FPA but rather are an independent grant making endowment fund who has as its mission helping people take control of their financial lives by connecting the financial planning community with people in need through support of pro bono advice and outreach activities.

I was disappointed not because we are seeking publicity for recognition’s sake but rather for all the individual planners (9500 of them at this point) who have made a donations to the Foundation as well as the strong support of many corporations. I think they like to know how their money is being spent.

Alexandra Armstrong, Chairman

Armstrong, Fleming & Moore Inc.

Washington, D.C.

Tell Us How You Really Feel

I read your article “Board to Death: Reloaded”, September 2006, and am not really sure where you stand.

Perhaps it is time that the CFP Board acknowledge that they really do not have the financial nor operational resources to regulate the planning world and just promote the CFP mark as educational.

I know that if the proposed ethics guidelines are issued as suggested that they do a disservice to the public. I am also not suggesting that all CFPs must act as Fiduciaries because obviously the wire houses would not allow that. Realism must trump misplaced idealism when dealing with this subject.

Morris Armstrong, CFP ,ChFC, CDFA

Armstrong Financial Strategies

Danbury, CT

These Just In…

The Investment Advisor editorial family is growing by leaps and bounds. In September we gained a talented, enthusiastic staff editor, Kara Stapleton, while our art director, Scott Valenzano, continued his creativity by celebrating the birth of his first children–twins Ian and Isabella. Welcome, Kara, and congratulations to Scott and his wife, Lisa Valenzano.


In the August Insurance Update, we misspelled the name of the long-term care insurance specialist we quoted from Mass Mutual. His name is Jeff Raelson.


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