Income annuities, investment trends and the Twinkies guide to the state of the economy
With the prospect of "taxmageddon," fiscal cliffs and limited deductions for life and annuity prospects on the table, this non-systemic risk can be managed by the advisor through due diligence. Otherwise if 70 percent 1035 rates continue in the future for the annuity industry, it will be no different than swapping Main Street's money for Wall Street's, or a Ponzi scheme.
In our house, we have the Twinkies guide to the state of the economy. Prosperity is when we have Twinkies after every meal. Recession is when we have Twinkies after every other meal, and depression is when Twinkies are every other meal. I don't eat Twinkies any more for fear of being arrested, but what does inspire me in the last lap of the year in a weakening economy is watching portfolio managers pull out all the stops in Q4 to beat their benchmark and peer group so that next year they can tout their glorious numbers on the front cover of Money Magazine. Hear we go again.
At a time when the financial markets are extremely prone to a systemic crisis, bond fund managers especially are taking more risk in the hopes they can squeeze another half-point return out of the Fed's recent QE3 action by again promising to buy another $40 billion per month in mortgage-backed securities. Systemic risk is the risk of a widespread collapse, and nearly occurred in 2008 (some would say it did) and the run on the banks in the early 1930s. For culture as a whole, it would refer to the London Millenium Bridge collapse in 2000 or the collapse of the bridge in the Twin Cities later. A few wobbles and then everyone's wobbling, causing events that were not included in the original blue print of grand design for either bridge. Call them unprecedented Black Swan events.
Right now, the most popular category of mutual funds, bond funds, are pulling the equivalent of "style drift" with stock funds by straying far from what their prospectus objective tells them they should be doing. As the Wall Street Journal pointed out on Saturday, September 29, the funds are straying far from the index they are measured against, which is a sure sign of additional risk. With $204 billion flowing into bond funds this year at record low interest rates, these funds are beating their benchmark and creating, along with some increased leverage, undue risk. Many funds that use the questionable and controversial Barclays U.S. Aggregate Bond Index are investing in leveraged bank loans, high yield bonds and emerging debt. These investments are not even in the index. While this is not all bad, investors and advisors should realize there is a huge difference between the spirit of a prospectus and the law of the prospectus. Some managers understand and abide by the prospect; some do not. So, what should savers and investors do? Realize that we live in the Age of Speculation, with annual stock turnover soaring to 215 percent in 2008. In 1951, it was 25 percent. The average holding period for a stock in 1960 was 8.3 years. Today, it is 1.4 years, meaning that, as John Bogle of Vanguard pointed out, $400 billion per year is deducted from investor wealth and kept by Wall Street. With derivatives soaring from $920 billion in 2001 to $700 trillion this year, this gargantuan capital market is not only the globe's largest but six times the GDP of the entire world. Credit default swaps represent $600 trillion of the total. What ever happened to the moral fortitude of advisors standing up for back end charges, early withdrawal penalties and market value adjustments that keep an investor's compass pointed northward and a crooked path straight?
A major insurance company recently said it would not allow a 1035 exchange unless a transferred annuity was held three years at a minimum. It has been proven time and again that investors whose liquidity is limited do much better than those who can freely trade. The difference between a day trader and a pigeon is that the day trader can still make a deposit on a Mercedes. If the realities of an income for life are to be realized and insurance companies are able to keep money invested as an asset to match their liabilities, the risk must be controlled to help income rider rates, roll-up rates and annuity withdrawal rates to be realized at a reasonable prize.
Retirement plans are beginning to experiment with income annuities, as Southwest Airlines is doing in their 401(k) plan. The NAIC is talking with the Department of Labor about the advent of including index annuities as a private pension alternative in plans. Advisors should be asking rollover prospects, "If it is good enough for the government and a great company like Southwest, shouldn't it be good enough for your plan? With the prospect of "taxmageddon," fiscal cliffs and limited deductions for life and annuity prospects on the table, this non-systemic risk can be managed by the advisor through due diligence. Otherwise if 70 percent 1035 rates continue in the future for the annuity industry, it will be no different than swapping Main Street's money for Wall Street's — or a Ponzi scheme.