As a securities attorney, I spend much of my time helping other attorneys prepare their cases for hearings before the SEC, FINRA and various state regulatory agencies or acting as an expert witness. When I am not involved in these activities, I spend a significant amount of my time on the road lecturing to financial professionals about annuities and retirement planning. In my work, I’m constantly asked my opinion of fixed indexed annuities (FIAs) and whether I believe they are appropriate investments. My answer is always the same: All financial products are appropriate for certain investors. However, all financial products can be sold in such a way that they would not be suitable for some investors. For example, a managed commodity account might be an appropriate investment for a young physician making $500,000 a year, but such an investment clearly would not be suitable for a 60-year-old widow with a small retirement nest-egg.
Hardly a month goes by that I don’t read an article in some financial magazine or newspaper claiming that FIAs are not appropriate investments for anyone. These articles almost always compare the FIA to equity investments such as a portfolio of stocks or mutual funds. The reporters making these comparisons are quick to point out that FIAs, unlike stocks and mutual funds, do not receive dividends nor do they provide the full upward movement of the stock market. The problem with such comparisons is that the reporters who make them assume that anyone who purchases a FIA would also be a good candidate for owning a portfolio of stocks or mutual funds. Such an assumption is rarely accurate and demonstrates just how little the reporters who criticize FIAs know about these products.
By applying this same flawed assumption, U.S. Treasury bonds would be an incredibly poor investment for anyone. The reason for this is that U.S. Treasury bonds don’t receive dividends nor do they receive the full upward movement of the stock market. To reach the absurd conclusion that no one should own Treasury bonds, one would have to assume that anyone who wanted to buy these bonds would also be equally willing to invest their money in the stock market. Obviously this is not true. An elderly investor might feel comfortable having his money in U.S. Treasury bonds where he receives a small but guaranteed rate of return on his money coupled with principal protection without having to worry about the vacillations of the stock market. Such an investor would not be a good candidate for owning a portfolio of stocks or mutual funds.
What an investor wants
Before any comparison can be made between any two financial products, a baseline question must be answered – what does the investor need from a potential investment? For example, if an investor wants to invest his money for a relatively short period of time and receive a rate of return that could be greater than what he might receive from bank CDs while protecting his principal, he would be an excellent candidate for a FIA but a poor candidate for a stock portfolio or mutual fund. Without understanding what an investor needs from an investment, any attempt to compare the FIA to a portfolio of stocks or mutual funds becomes a useless exercise.
By analogy, one could argue that automobiles should never be purchased by anyone living in the United States because they’re a poor alternative to an ocean liner. This statement would only be valid if it is assumed that every potential purchaser of an automobile is planning to travel from New York City to London. However, if one plans to use his automobile to travel to and from work, visit friends or go to their child’s soccer game, the automobile is a much better vehicle than an ocean liner. As a matter of fact, attempting to travel 10 miles to work and back on an ocean liner would be a rather stupid exercise.
When comparing FIAs to a portfolio of stocks or mutual funds, one needs to determine what the investor needs from an investment. Unlike reporters, financial advisors must take the time to determine which financial product meets the specific needs of their clients. If an investor is young, has a job with a good salary and can accept some risk, then she might consider buying a portfolio of stocks. If an older or more conservative investor wants principal protection and a rate of return that could be three or four times what he is receiving from bank CDs or money market accounts, the worst investment he could make would be a portfolio of stocks because neither of these investments would provide what this older investor is seeking from an investment.
I recently talked with an ultra-conservative investor who purchased a five-year FIA that would pay between zero percent and 8 percent a year based on stock market performance. For the first three years of his investment, he received 8 percent. Assuming for the last two years of his holding period he receives zero percent, he will still have received an average return of nearly 5 percent a year without putting his money at risk. The money he used to buy his FIA came from a money market account paying him less than 1percent a year.
Good financial advisors always determine what their clients need from a potential investment, their risk tolerance and other factors before helping them select the investment that best matches their clients’ needs. The individuals who write negative articles about FIAs have no obligation to determine the needs of investors when comparing FIAs to other investments. The only obligation these intellectually lazy reporters have is to crank out the same old articles based on defective assumptions.