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'You Can't Cheat An Honest Man' Applies To VAs, Too

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One of our favorite movies is the 1939 classic, “You Can’t Cheat an Honest Man.”

Written by and starring W.C. Fields in one of his signature roles as a circus con-man, the story details how people’s greed can get the better of their common sense.

While we would not impugn the honesty of the average retiree, we think there may be some similarities to a current problem in the financial marketplace – people using variable annuities to opt for early retirement on a basis that defies economic reality.

The National Association of Securities Dealers, on Sept. 14, 2006, released an NASD Investor Alert entitled “Look Before You Leave: Don’t Be Misled By Early Retirement Investment Pitches That Promise Too Much.”

This release describes certain instances of what are characterized as broker misconduct in pitching a strategy recommending that people take retirement earlier than they might otherwise, investing their accumulated retirement funds in risky investments. Among the risky investments listed were VAs, mutual fund shares and exchange-traded funds.

Any sales program that uses misleading, inaccurate or fraudulent materials is deplorable. But the alert creates a bit of a quandary. Specifically, why are the consumers who undertook these programs exempt from responsibility for obtaining a realistic understanding of their retirement options and particularly for subscribing to a scheme that defies economic reality?

The NASD release does not give much in the way of details about how much erroneous information these consumers received. But the release does state that the retirees subscribed to strategies that had annual withdrawals of 7.5% to 9% of the customer’s initial investment with regular increases at periodic intervals, at rates projected to be sustained for retirement periods of more than 30 years!

Moreover, these schemes would require a consistent annual investment return of 11% to 14% – not an average return over the period, but a consistent annual return!

Even unsophisticated investors should have some idea of realistic potential investment returns – unless, like the dishonest man in the movie, they have let greed overcome common sense.

It is not sufficient to take the position that the people who lost money in these schemes relied on professionals to guide them. This is not to excuse the sales people who perpetuated this scheme. But one wonders how so many people could have suspended reality by taking what was said as absolute fact, rather than checking the proposals to see if they were realistic.

Except for rock stars or professional athletes, most people are eager to retire. Work, as the word connotes, is work. Most would opt for something other than work, if we had the choice.

Perhaps these people were so eager to escape work that they allowed their common sense to be suspended in their eagerness.

It would seem that this is a form of greed akin to dishonesty – a rush to quit employment in hopes that a speculative scheme would work, no matter how improbable. Then, in keeping with today’s atmosphere of institutionalized victimization, the bad end result is made into someone else’s fault.

The NASD Investor Alert details one retirement problem, but it begs a larger question: How much responsibility does the investor have to educate himself about the realities of investment in order to avoid unnecessary risks?

It may well be that the NASD does a disservice to the investing public by homing in on one scam rather than attempting to educate consumers about the reality of the investment and retirement process.

Did the people who were damaged by the scheme outlined in the NASD Investor Alert truly believe they could garner returns of 11% to 14% on a continuous basis and withdraw 7.5% to 11% for a 30-year period without any consideration of down markets, periodic market adjustments and the inexorable erosion that accompanies large withdrawals of principal? If so, these people need an education before they are permitted to invest in the marketplace.

The NASD Investor Alert did not give details about the VAs purchased as part of the program. But we have seen a number of early retirement programs involving VAs.

In many instances, the company-sponsored retirement plans that employees are converting into VAs have investments no less speculative than the investments that underlie the VAs. In many instances, these retirement programs have investment portfolios heavily concentrated in the employer’s stock and far more volatile than the eventual VA the employees purchase.

In actual fact, the investors stand to lose far less with their investments under the VA than they would lose by staying in the employer’s retirement plan. Moreover, the VA affords lifetime income and other guarantees – something not available with continued participation in defined contribution retirement plans.

The NASD Investor Alert does consumers a good service by informing them of types of schemes to avoid. Nevertheless, it does a disservice by leading investors to conclude that investments in VAs are never appropriate for early retirements or perhaps even for retirements in general.

Consumer education about investment is the answer to these problems.

Consumer education will ensure that investors avoid scams and that they understand the realities of the investment process. Regulators and the investment industry both have a responsibility to foster investor education. After all, “an informed consumer is our best customer” applies across the board to everything that is consumed–not just to discount clothing.