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Life Health > Annuities > Fixed Annuities

Don’t Let Your Clients Be Fooled by Wall Street Math

By Marty Becker

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What You Need to Know

  • Some financial planners question the value of annuity guarantees.
  • The author makes the case for the kind of stability annuities can offer.
  • He says guarantees can help end-of-period returns.

It’s not uncommon that a client will tell me that the market has returned 8%, on average.

Or that they have had an 8% return on their money, so why would they want to put it into a safe-money product that possibly could return less, even though there is a guarantee it will never go backward?

This is where knowing the difference between average returns and actual returns can make a big difference for your client. What your clients see on their statements is not what they are getting.

How is that possible? Because they are being shown an average return. Let me demonstrate:

Average Investment Return: 25%
Actual Investment Return: 0%
YEAR Beginning-of-Year Account Value Earnings Rate Interest Earnings End-of-Year Account Value
1 $100,000.00 100% $100,000.00 $200,000.00
2 $200,000.00 -50% ($100,000.00) $100,000.00
3 $100,000.00 100% $100,000.00 $200,000.00
4 $200,000.00 -50% ($100,000.00) $100,000.00
TOTALS 25% $100,000.00

What most institutions will do when sending statements is they will take all of the returns added together and then divide them by the number of years. That’s pretty simple and something we all learned in fourth-grade math. However, that is not the whole truth about their money and is actually a misrepresentation of how well they are doing financially with their investments.

At the end of the day, the only thing that matters is how much they started with and how much they ended with. This is an extreme example, but you can see how people can be fooled with these numbers, even though they know deep down that something isn’t right. And we haven’t even accounted for fees and taxes yet!

So, how does this translate to you as an advisor that wants to recommend a safe money product that will protect your clients from loss?

When you can show your clients what a variable investment could return vs. a product that mitigates results, it gives them a whole new framework.

Let me give you an example:

Let’s say your client put money into an equity investment, and they have been told they have gotten an average 7% return on interest. But you are explaining the importance of protection and mitigating losses and fees. On the surface, their average returns have been 7%, but their actual returns are less than 5%. Because once to take into account just one downturn in the investment and management fees, that drastically drop their actual return.

Average Investment Return: 7.00%
Actual Investment Return: 4.95%
YEAR Beginning-of-Year Account Value Earnings Rate Interest Earnings Misc. Fees End-of-Year Account Value
1 $100,000.00 10% $10,000.00 ($1,650.00) $108,350.00
2 $108,350.00 10% $10,835.00 ($1,788.00) $117,397.00
3 $117,397.00 10% $11,740.00 ($1,937.00) $127,200.00
4 $127,200.00 10% $12,720.00 ($2,099.00) $137,821.00
5 $137,821.00 -20% ($27,564.00) ($1,654.00) $108,603.00
6 $108,603.00 10% $10,860.00 ($1,792.00) $117,671.00
7 $117,671.00 10% $11,767.00 ($1,942.00) $127,497.00
8 $127,497.00 10% $12,750.00 ($2,104.00) $138,143.00
9 $138,143.00 10% $13,814.00 ($2,279.00) $149,678.00
10 $149,678.00 10% $14,968.00 ($2,470.00) $162,176.00
TOTALS $81,890.00 $19,714.00 $162,176.00

Oh, and don’t forget to point out that they still had to pay a management fee in the year they lost money.

But what if they were willing to take a portion of their money and put it into a safe-money product that only gave them a 70% participation rate of an index, but it protected them from a loss in a downturn. It had no fees associated with it. How would it look?

Average Investment Return: 6.30%
Actual Investment Return: 6.28%
YEAR Beginning-of-Year Account Value Earnings Rate Interest Earnings Misc. Fees End-of-Year Account Value
1 $100,000.00 7% $7,000.00 $ - $107,000.00
2 $107,000.00 7% $7,490.00 $ - $114,490.00
3 $114,490.00 7% $8,014.00 $ - $122,504.00
4 $122,504.00 7% $8,575.00 $ - $131,080.00
5 $131,080.00 0% $ - $ - $131,080.00
6 $131,080.00 7% $9,176.00 $ - $140,255.00
7 $140,255.00 7% $9,818.00 $ - $150,073.00
8 $150,073.00 7% $10,505.00 $ - $160,578.00
9 $160,578.00 7% $11,240.00 $ - $171,819.00
10 $171,879.00 7% $12,027.00 $ - $183,846.00
TOTALS $83,846.00 $ - $183,846.00

Even though they are not getting 100% participation in the upswing, they are getting 0% participation in the downturn. Oh, and they’re not paying any fees either.

When you know how to do the math, you can demonstrate that their actual return is much lower even though their average return is higher on paper. In this example, it’s the difference of a little more than $20,000! That’s where you can make the most difference as an advisor by knowing how these safe money products (in other words: annuities) work and giving them a visual reference.

As an advisor, when you have the tools to demonstrate concepts like Wall Street math to your clients, it can make all the difference to them and you.

Marty Becker Marty Becker is the president and owner of Atlas Financial Strategies.

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