Here’s Why I’m a “No” on Annuities

Written by Rob Copeland | 30 May 2023

Annuities are more popular than ever: Last year, buyers put a record $310.6 billion into the hybrid insurance and investment products, and sales are still going strong. Fixed-rate annuities, which guarantee a rate of return over a set time period, did particularly well, more than doubling their sales from the previous year.

Why are annuity sales surging? One reason is that stocks and bonds both had terrible years in 2022, and they haven't been stellar this year either. Meanwhile, the Federal Reserve has raised interest rates aggressively, fueling recession fears. Both factors have made annuities, with their promise of predictable income streams, look like a safe haven. In addition, those rising interest rates have also translated into higher annuity payouts.

Early in my career I really liked annuities. They provide that reliable stream of income over a specific period or for life. They can help provide financial stability during retirement, and help mitigate the risk of outliving your savings.

But I quit selling them 15 years ago. One of my big concerns with annuities is that there's a huge incentive for financial advisors to push them on clients. The sales commissions are typically 5% or 6%. So if an advisor sells a $1 million annuity, he or she pockets a quick $50,000 or $60,000. It's easy for advisors to overlook the question of whether an annuity is right for their client when they know recommending one could put a new Tesla in their driveway.

By the way, I never receive sales commissions for selling any financial product. As a fee-only, fiduciary advisor, I'm paid strictly for giving objective advice about investing and financial planning.

Annuities also lock up your money, typically for five to 10 years. During this "surrender period," if you withdraw more than a certain percentage of your annuity's value, you may be subject to steep surrender charges. Surrender charges typically start at 7% in the first year and decrease by 1% each subsequent year until they reach 0%.

Tying up your money for several years also carries an opportunity cost. In other words, you may miss a change to earn higher returns elsewhere. If, for example, we get another bull market where you have a chance to earn 10%, 15% or 20% returns, you'll have to settle for single-digit returns from a fixed-rate annuity.

It's true that you can earn more using an index-linked annuity. But annuities in general tend to have higher overall costs and fees than, say, mutual funds due to their insurance features, guarantees and administrative expenses. And the returns of index annuities are typically capped so that the insurance companies that issue them can ensure that they make a profit. In other words, you can leave money on the table with an index annuity.

Finally, annuities can create bad tax situations for both their owner and any heirs. Annuities aren't tax-free, they're tax deferred. And they're taxed as ordinary income, which is a higher rate than the capital-gains rate that applies to stocks and bonds. And it's impossible to say what your income-tax rate will be during the course of your retirement. If you're in a high tax bracket, you could really get walloped.

Furthermore, if you pass away while holding an annuity, your beneficiaries may not receive a step-up in tax basis as they would with stocks and other kinds of investments. This means that any gains that have accrued within the annuity would be subject to income tax when the beneficiaries receive distributions.

There are probably cases where annuities make sense for certain people, but I'm hard-pressed to name one. With the benefit of 24 years' experience as an investment advisor, I've come to believe there's pretty much always a better alternative. Don't hesitate to reach out to me if you'd like to learn more.

“Sell in May Go Away” is Not the Way

Written by Rob Copeland | 08 May 2023

There's an old saying that investors should "sell in May and go away," the idea being that stock returns are historically poor during the summer months. The idea is factually dubious. But right now, many investors are staying out of the market anyway--because they're worried about a recession, a bank crisis and inflation. I believe that's a big mistake.

In the current environment, perception and reality are at odds with each other. If you look through all the gloom and doom about those aforementioned market headwinds, what you'll see are really good corporate earnings. A few recent examples of great first-quarter earnings are
Ford Motor, Alphabet and Meta.

Inflation may have been a problem for many companies a year ago, when it really started to spike. But if you've bought anything at all since then, you know that companies have jacked up their prices and then some. And while businesses' costs—for things like raw materials and labor—have started coming down, they're not passing those savings on to customers. Consumer spending is still strong, so why should they? This dynamic explains why corporate revenues and profits are doing so well.

Yet the S&P 500 has bounced around all year, and is still down 13% since start of 2022. Investors are gloomy because of endless headlines about a likely recession, about inflation, about the possibility of another bank crisis. But what if everything isn't terrible? A recession is far from a sure thing, as evidenced by the surprising news that employers added 253,000 jobs in April, bringing the unemployment to 3.4%. We've already talked about how inflation has actually helped businesses.

The possibility of a bank crisis still looms. And while it's hard to say what will happen, the Federal Reserve and U.S. government have proven again and again that they will step in to protect the economy should a major crisis erupt. What's more, the Fed is signaling that its cycle of interest-rate increases is likely over. That would mean a major economic headwind is about to disappear.

The gap between perception and reality is an opportunity for investors. Right now, many great companies' stocks are bargains, thanks to irrational market behavior. I'm buying selectively on market pullbacks. I believe that even if companies' stock prices stay unfairly suppressed, that certain ones will pass their strong earnings along to shareholders through dividends or stock buybacks. And then appreciation will happen in the long run.

If you're too nervous to commit to stocks, you should note the attractive yields are available on safe investments. Six-month Treasuries, for example, were recently yielding more than 5%, their highest level in many years. Stocks have historically provided more growth over the long run than bonds. But owning bonds is far superior to having your cash on the sidelines, being eaten away by inflation. Sell in May and go away? It rhymes, but it's wrong. Don't hesitate to give us a call if you'd like to talk about your investments.

Take the Long View, Ignore the Scary Headlines

Written by Rob Copeland | 31 March 2023

You've probably been seeing lots of scary headlines lately: the failure of a few banks and the possibility that others will follow suit. A looming recession. The possibility that artificial intelligence threatens the future of humanity.

The only thing that's clear in all of this is that these headlines are getting a lot of clicks. A widespread run on banks? With the crisis being contained to a few institutions, that seems less and less likely. Recession? Investors and business leaders have been predicting a recession since early last year and it hasn't happened yet. If it does, there are indications that it may be mild and brief. As for our A.I. overlords, expert opinion is very divided, and you and I worrying about such a scenario won't accomplish anything.

The media, including social media, loves scary topics because they attract far more eyeballs than benign ones. But many investors do more than just click on the articles. Frightened that their wealth is at risk, they often react by selling. Some have recently pulled all their money out of bank stocks, or even the entire market. But what's interesting is that amid all of 2023's scary headlines, the stock market's up almost 6%.

Scary headlines can be accompanied by bad stretches in the market or good ones. But investors who react to each instance of bad news by buying and selling probably won't make much money over time, and may end up losing money.

The more active you are in the market, the more decisions you have to get right. You have to get out of a stock or of the market at the right time—a hard task because you don't know if the stocks you're dumping will take off the day after you sell. You have to get back in at the right time and, again, hope that the market doesn't tank as soon as you rejoin it. And if you're reacting to the day-in-day-our news flow, you have to be right again and again and again. The odds of accomplishing that, and of earning a positive return over the long term, are very low.

The key to successful investing is using a long-term lens. Research from investment firm Dimensional Fund Advisors has found that the likelihood of an S&P 500 investor losing money declines as period of the investment grows. It found that over one-day periods, the index declines 46%. Over a year, it declines just 26% of the time, and over 10 years, that number falls to 6%. There are always ups and downs within the long term, but the pattern—that the stock market rewards you if you're patient—plays out with remarkable consistency.

Some investors use a five-year lens. Others a 10-year lens. The right timeframe will depend on your personal factors, including the number of year until your retirement or other goals. This doesn't mean that investors should ignore their portfolio for five or 10 years. There will always be opportunities along the way to fine-tune your investment mix in order to position for the best possible return with the least amount of risk. For instance, bond yields have strengthened significantly in recent months, which may give you an opportunity to lower overall portfolio risk while earning a good return.

It can be hard to be patient and take a long-term view when scary headlines are swirling. It can feel good simply to take action—any action! But in five or 20 years, you'll thank your past self for thinking long-term. Don't hesitate to contact us if you'd like an investment portfolio review.

Improving Bond Yields and the Case for Rebalancing  

Written by Rob Copeland | 28 February 2023

Owning bonds hasn't been very attractive for the past few years, and 2022 was the low point. A cross-section of bonds, as represented by the Bloomberg Aggregate Bond Index, registered a 15% loss in 2022. And with interest rates low for much of last year, bonds provided very little if anything in the way of yield.

Things look a lot different this year. Yields on all types of fixed income are way up, thanks to the Federal Reserve's campaign of raising interest rates to fight inflation. And while the bond market as a whole is flat, fixed income is once again looking like it belongs in investment portfolios.

Bonds' traditional role in an investment portfolio has been to balance the risk of stocks, which historically have been more volatile than bonds. Stocks, meanwhile, are supposed to provide more long-term growth than bonds. However, bonds prior to this year yielded so little, and performed so badly, that they did nearly nothing to mitigate portfolios' risk.

As a result, many investors gave up on bonds and piled into stocks, causing once-balanced portfolios to become lopsided—and riskier—in favor of equities. Now is a good time to take a fresh look at your portfolio, and to make sure you have enough diversification to get good long-term returns without undue risk.

It might be tempting to stay overweighted to stocks. After all, the S&P 500 index of stocks returned 27% in 2021, 16% in 2020 and 29% in 2019. Those years were anomalies however: The S&P's annual return has averaged less than 10% over the past 20 years. And as we saw last year, when the S&P fell 19%, stocks can be very volatile.

Could bonds have more bad years? Of course; no investment is guaranteed to make money. But positive yields mean better overall returns. Safe, short-term treasuries are yielding as much as 5% right now; many corporate and muni bonds yield even more. Even one-year CDs are yielding more than 4%.

In deciding on a mix of investments, it's important to use your goals as your guide. If retiring comfortably requires an 8% return over the next 15 or 20 years, there's no need to take the kind of stock-heavy risk needed to earn a 15% return. The point of investing isn't to bet the farm on gaudy returns. It's to help you achieve real-life goals on your individual timeline, without the risk of blowing up your portfolio. With fixed-income investments looking better than they have in years, this is a very good time for a portfolio checkup. If you agree, don't hesitate to call us.