Overall articles on economics and retirement income planning with annuities.

The Financial Instability Council- More Beltway Madness

Financial Instability Council

Red Tape- More Rules Where None Are Needed

This week brings an important editorial from the Wall Street Journal on the continued overreaching and regulatory creep oozing out of Washington.

Today’s editorial, perfectly titled “The Financial Instability Council” discusses the bass-ackwards attempts of power hungry legislators  to roll perfectly stable insurance companies up in a regulatory coffin and sink consumers with higher premiums to pay for this added compliance nightmare.

Rock solid insurers Met Life and Prudential are at risk of being tarred with the regulatory stigma of “Too Big To Fail.  Thankfully, they are valiantly fighting this mess.  Let’s hope the win, and write your representatives to fight this off.

“Too Big To Fail” has a definite meaning, and Dante is working on a special 10th Circle for firms labeled this way.  Banks known as “Too Big To Fail” were of course all overseen by the Treasury’s Office of Thrift Supervision up thru and including the financial crisis… meaning, they were under the watchful eye of the Treasury as the financial crisis unfolded, and as the US Taxpayer was thrust into the fire to backstop the mess…

As the Journal states,

“So of course Treasury’s solution is to expand federal regulation to the businesses that weren’t overseen by the department and didn’t fail.  Makes perfect Beltway sense.”

Firms now deemed as ‘systemic risks’ are saddled with added regulation and capital requirements.

“Along with the “systemic” designation comes regulation that was created for banks, not for insurance companies, and that will create problems for taxpayers and policyholders. Any firm dubbed “systemically important” will be regulated by the Federal Reserve. This will likely mean heavy new capital requirements designed to prevent problems that generally don’t exist at an insurer.”

Another great quote from the article is this:

It’s a giant and counterproductive leap to conclude that the insurance business presents a systemic risk to the financial system.

Read the whole piece online HERE and be sure to write your representatives and senators to resist this continued counterproductive bureaucratic expansion.  The body of the article is below:

There’s finally a healthy discussion in Washington about how to end too-big-to-fail banks. But before the government can start getting rid of taxpayer-backed behemoths, it first has to stop creating them.

The 2010 Dodd-Frank law classified all banks with more than $50 billion in assets as systemically important, and the federal Financial Stability Oversight Council (FSOC) is considering which non-banks should also be deemed too big to fail. Last year the board of regulators slapped the systemic tag on eight “financial market utilities,” including clearinghouses, which means taxpayers now stand behind derivatives trading. Congratulations.

And last week the council, chaired by Treasury Secretary Jack Lew, declared that GE Capital, the finance arm of General Electric, GE -0.85% and AIG are also officially important. Now the council is trying to designate insurer Prudential as systemic, and perhaps MetLife MET -0.99% too.

GE Capital was rescued in the 2008 panic and thus deserves the systemic label. AIG seems to welcome the designation, perhaps because its current mix of businesses means that it will face a lighter regulatory burden than some competitors. But taxpayers should be cheered to learn that Prudential and MetLife are resisting membership in the too-big-to-fail club, and for good reason. It’s a giant and counterproductive leap to conclude that the insurance business presents a systemic risk to the financial system.

AIG was a giant insurer when it failed, but its disastrous housing bets largely occurred outside its traditional insurance businesses, which have always been regulated by the states. The company’s catastrophic wagers on the mortgage market were overseen by the U.S. Treasury’s Office of Thrift Supervision. So of course Treasury’s solution is to expand federal regulation to the businesses that weren’t overseen by the department and didn’t fail. Makes perfect Beltway sense.

But this logic should give taxpayers pause. Along with the “systemic” designation comes regulation that was created for banks, not for insurance companies, and that will create problems for taxpayers and policyholders. Any firm dubbed “systemically important” will be regulated by the Federal Reserve. This will likely mean heavy new capital requirements designed to prevent problems that generally don’t exist at an insurer.

Banks accept short-term liabilities in the form of deposits and use them to fund long-term loans. This “maturity transformation” has wonderful economic benefits but carries the risk of failure if lots of depositors suddenly want to withdraw their funds. To address this risk, banks are required to maintain capital cushions and liquidity to meet deposit withdrawals that can occur at any time.

Insurers, by contrast, match long-term liabilities with long-term assets. Premiums to cover some event likely to occur decades in the future are invested in assets of a similar duration. There is little risk of a “run on the bank” because policyholders, unlike depositors, typically cannot demand the face value of their policies in cash. Tornadoes, car accidents and terminal cancer do occur, but they don’t occur everywhere at once, and they are not triggered by a panic in financial markets.

Insurers can fail, but since customers cannot immediately demand their money the way bank depositors can, the failures tend to play out slowly over many years. States also typically require insurers to contribute to a fund to make up for the shortfall if one of them fails and its assets and liabilities don’t match. Without the same immediate demands for cash as at a bank that’s heading south, there is less risk of an asset fire sale that could roil markets.

Treating insurers like banks would also raise costs substantially at insurers as they scramble to comply with the new burdens. This means higher premiums for customers. MetLife hired consultant Oliver Wyman to calculate the consumer costs of bank regulation if applied to several insurers that could potentially fall under federal bank rules. The industrywide estimate: $5 billion to $8 billion a year.

If companies can’t pass along these higher costs to customers and stay competitive, they are likely to exit the business, especially the capital-intensive life insurance market. That would mean less competition.

The other big risk is that the systemic risk designation could turn out to be self-fulfilling. If an insurer has to accept bank regulation, it might as well consider expanding into bank businesses. If it has to pay the regulatory costs of holding short-term liabilities, then the natural next step is to consider relying more on short-term funding, which almost everyone agrees was a key vulnerability leading into the 2008 crisis. Insurers may become riskier institutions than they now are, which means more risks for taxpayers.

This is no idle fear because the only certainty about financial regulation is that it never prevents the next crisis. Yet in order to reinforce the illusion of effective regulation, and vindicate the folly of Dodd-Frank, regulators are about to force insurance companies and customers who didn’t cause the last crisis to pay more while encouraging firms to pursue riskier business thanks to an implied federal backstop. They should have called it the Financial Instability Council.

 

How Annuities Mitigate Inflation Risk

money-bill-inflationInflation is the gradual erosion of the purchasing power of your dollar.  Inflation has averaged about 3.3% per year from the start of the US Government data set in 1910 to today- this includes the galloping years in the 1970’s. Check out the Government’s own Inflation Calculator HERE:

Now, I’ll be clear, an annuity itself will not protect you from inflation.

What an annuity CAN do, however, is increase your overall safety AND simultaneously allow you to invest more aggressively.  Let me explain…

How A Flooring Strategy Helps:

One of the primary benefits of ‘flooring’ your income with a guaranteed annuity is that you can invest the rest of your assets for more growth.

It is growth, and exposure to assets that are resilient and increase in value with inflation, that will protect you in the long run.

So here’s the thing- how can you have exposure to ‘risky’ growth assets while safely protecting your nestegg? It’s actually quite simple….

By allocating a PORTION of you assets to be dedicated to guaranteed income in an annuity, you free up the REST of your assets to be safely invested for growth!

If you are protecting one pile of money, and simultaneously trying to make it grow AND be safe AND produce income, all at the same time (traditional asset management and systematic withdrawals), you are running a grave risk.

Because of the competing priorities, the performance of that one pile of money trying to perform well on each of these different fronts will be compromised.  Your money is divided, and you’ll be conquered

Instead, by allocating a portion for income in an annuity, and allocating a different portion to growth, the growth portion can simply grow…. without pressure to sell in a down market for income… and without pressure to be conservatively allocated for safety….

This gets to the heart of our approach, namely, to put yourself in a position of strength by building a floor level of guaranteed income to cover your essential expenses.  Then the rest of your assets can be more aggressively invested, yet your overall risk profile is quite safe.

It just makes sense.

Conventional “Wisdom”

Wall Street’s usual recommendation is to be increasingly weighted to bonds as you get older, for safety and income.

Following this poor advice, not only are your assets at grave risk of loss due to interest rate rises, but you are likely NOT invested in assets that can jump with inflation, such as equities, metals, or real estate.

You could be stuck nursing an overweighed conservative portfolio in an inflationary environment, losing purchasing power, yet not be able to allocate to growth for fears of volatility or loss.

Following the ‘Thundering Herd’ and conventional wisdom, you’ll get trampled to death.

Inflation Risk Summary

Inflation needs to be recognized, and many people shy away from annuities due to inflation fears.

However, a guaranteed income from an annuity actually frees your remainder assets to be invested for growth and inflation protection WITHOUT the pressures of safety and income on those remainder assets.

Therefore, guaranteed income from an annuity is actually a critical component of an optimal inflation protection strategy.

Want a Guaranteed Loser? Try TIPS

Newsweek Inflation ImageBond yields are at all time lows, and with Treasury Inflation Protected Securities, or TIPS, you can go even lower.  You can buy now for a guaranteed loss.

What a world we’re living in!

The issue with TIPS is that the yield is keyed to interest rates AND inflation.  And with both at all time lows, buying a TIPS style bond now means you will be in for a losing ride in real (buying power) terms.

The Wall Street Journal published a good article on the topic, HERE, and it’s quoted below

Would you buy an investment that was guaranteed to lose money?

That is the situation investors are embracing today in the market for Treasury inflation-protected securities, or TIPS—bonds issued by the U.S. Treasury whose value is designed to keep up with consumer prices.

The effective interest rates on TIPS have collapsed to record lows. It is mathematically impossible now for investors to earn respectable returns from any of them, and in many cases they are a lock to lose money in real, inflation-adjusted terms.

This doesn’t mean you should dump all of your TIPS at once. But by selling long-term TIPS and holding only short-term ones, you can lock in your biggest gains today and reduce the odds that you will be stuck holding money-losing investments years from now.

TIPS, which have existed since 1997, are a fine idea on paper. The principal adjusts twice-yearly to take account of changes in the consumer-price index. So for the life of the bond, the investor is guaranteed that his investment will keep up with inflation and earn an additional interest rate, known as the “real return.”

Typically, say analysts, these bonds have usually been considered good value when they have offered a real return of 2% or more a year. That has approximated the average historical return, after inflation, of regular bonds.

Yet today’s TIPS yield a fraction of that.

The 30-year TIPS today offers a real return of inflation plus 0.5% a year. For TIPS coming due within the next 10 years, the real return is negative: Your investment is guaranteed to leave you poorer, in real terms, than you are now. A five-year TIPS today locks in an interest rate of inflation minus 1.4% a year. Over the life of the bond, investors will lose 7% in real terms.

Paul Winter, a 20-year veteran of the bond market now working as a fee-only financial adviser in Salt Lake City with $30 million under management, considers all TIPS a poor investment.

Yet they remain popular. FRC, a Boston firm that tracks the mutual-fund industry, says U.S. investors own at least $145 billion worth of TIPS through funds that specialize in them. The amount of TIPS in circulation has risen 50% in five years to $850 billion, according to the U.S. Treasury.

Investors have been buying TIPS in recent years for two reasons, say analysts. Some are looking for a better alternative for their short-term money than cash, which is earning almost 0%—and less than inflation. Others are looking for long-term protection against the risk of surging inflation.

Investors seeking short-term alternatives to cash should stick to short-term TIPS, preferably those that mature within five years.

The Federal Reserve, trying to kick-start the economy, is keeping short-term interest rates at zero and is taking action to drive down long-term rates as well. For savers, this means regular bank deposits, money-market funds and short-term Treasurys effectively lose them money each year. Short-term TIPS, while ugly, might be less so than the alternatives.

There is an argument for using TIPS as a safe-haven alternative to Treasurys. “If I buy nominal Treasurys right now, I can basically earn 0% in a 3%-inflation environment, so I’m losing 3% in real terms per year,” says Carl Friedrich, chief investment officer at Piermont Wealth Management in Woodbury, N.Y., which has $130 million under management.

By comparison, he says, some TIPS don’t look so bad.

Investors seeking longer-term protection against inflation should also stick with short-term TIPS. Even though long-term TIPS might offer higher real rates of return, they are much more volatile, Mr. Friedrich says. If interest rates rise across the economy, he says, those longer-term bonds could fall sharply in price.

“If you’re going to take a position in TIPS,” Mr. Friedrich says, “keep the maturity at the short end, ideally no more than five years.”

Logically, owning long-term TIPS will probably work out well only if the economy plunges into a multidecade deep freeze or bursts into rampant runaway inflation. In either scenario, one can expect plenty of volatility ahead—and many opportunities to earn better rates of return than half a percent a year.

The smart move now is to cash in gains on long-term TIPS.

Bonds are like seesaws: The yield falls as the price rises. TIPS yields have collapsed as their price has risen. The longest-term bonds, which are the most volatile, have risen the most. The February 2040 TIPS has risen 40% in price since it was issued three years ago. Investors are sitting on some hefty capital gains.

So it makes sense to cash those in. As an added bonus, the gains, assuming the bonds have been held for more than a year, will be taxed at a maximum rate of 23.8%. The annual income from the bonds, if held, will be taxed higher as ordinary income.

Investors still looking for long-term protection against the risks of high inflation in the future might find better value in real estate, such as in investment properties, and in commodities, both of which look cheap compared with their long-term averages.

Americans Rip Up Retirement Plans

New news from Conference board reported in the Wall Street Journal shows that nearly 2/3’rds of Americans are now planning to delay retirement.

Financial losses, a sluggish economy, and stubborn unemployment contribute to the delay in plans and decrease in expectations.  And meanwhile, the percentage of workers over 60 in the workforce is growing.

The article appears Here:

Many middle-aged Americans, though, drew down their savings during those lean years and now find that leaving the work force on their original timeline is no longer viable, he said.

They are also facing low interest rates, an uncertain future for Social Security, and a lower likelihood of receiving employer health insurance after retirement.

If your retirement plans are in a shambles, it might be time to consider how a guaranteed income annuity can create the solid foundation you need for a happy retirement.

It’s not about how much money you have- it’s all about how much income you can depend on.  It’s income that fuels a happy retirement, and there’s nothing better than a GUARANTEED income.

Give us a call, we can help.

4% Rule Under Fire- Again

4pctThe often-quoted ‘4% withdrawal rule’ that mainstream investment managers use as a guideline ‘safe’ withdrawal rate for a portfolio has come under fresh fire.

The volatility of the last few years should have already given most conservative investors enough heartburn to not stake their life savings on this faulty rule of thumb.  But new research is showing just how disastrous bad advice can be.  We’ve written about this flawed approach before as well.

The 4% Rule Background

The ‘4% Rule’ isn’t really a rule.  Rather, it’s an asset withdrawal rate promoted initially by a retirement planner named William Bengen.  The theory states that a safe retirement withdrawal rate starts out by drawing down just 4% of your portfolio and adjusting up only for inflation.  Testing against 75 years of historical stock and bond prices shows the probability of failure – meaning, the chance of running out of money in a 30 year retirement, at an acceptably low probability of about 6%.

Where It Falls Apart:

In its day, the “Rule” made sense, but that day was 1994.  The US had strong market performance year over year in the preceding decade, and portfolios grew at a solid rate even with withdrawals.

Well along comes the Tech Bubble, a Black Swan event, and then a Flash Crash, computerized trading, the lost decade of the 2000’s, the banking crisis, international currency crisis, and the real estate crash.  Oh yeah, THAT awful decade….

Retirees looking to their assets for income, and carrying their own longevity risk, saw portfolio values decimated, and at the same time were forced to sell securities while they were down for income.

Welcome to Reverse Dollar Cost Averaging- Getting kicked while you are down.

Well in case you didn’t already know from common sense, you can’t pull money out of a depreciated portfolio and expect it to bounce back and stay on track indefinitely.

The Case for Annuities:

I probably don’t need to belabor the point that annuities are MADE for times like this- quite simply, you buy security and safety of income, and offload major risks like longevity and loss of principal on a strong insurance institution. That’s all there is to it.  How we put together a plan for you depends on your needs and assets, so get started by giving us a call today.

 4% Rule- New Research

New research from a distinguished trio of academic and research economists has driven a new nail in this coffin.  Michael Finke, Wade Phau and David Blanchett have re-run the economic simulations that Bengen initially based his finding on with TODAY’s actual reality of low to negative real (after inflation) bond yields.

Instead of a 6% probability of failure, today’s rate environment produces an astounding 57% probability of portfolio ruin.  Remember, ruin means running out of money- kaput, no groceries, no roof over your head.  Does that sound a like a good way to spend your final years?  At 57%, this is almost a certainty of failure!

Here are several quotes from the Author’s excellent new study (Available Here):

The safety of a 4% initial withdrawal strategy depends on asset return assumptions.  Using historical averages to guide simulations for failure rates for retirees spending an inflation-adjusted 4% of retirement date assets over 30 years results in an estimated failure rate of about 6%. This modest projected failure rate rises sharply if real returns decline.

As of January 2013, intermediate-term real interest rates are about 4% less than their historical average. Calibrating bond returns to the January 2013 real yields offered on 5-year TIPS, while maintaining the historical equity premium, causes the projected failure rate for retirement account withdrawals to jump to 57%. The 4% rule cannot be treated as a safe initial withdrawal rate in today’s low interest rate environment.

Some planners may wish to assume that today’s low interest rates are an aberration and that higher real interest rates will return in the medium-term horizon. Although there is little evidence to support this assumption, we estimate how a reversion to historical real yields will impact failure rates.

Because of sequence of returns risk, portfolio withdrawals can cause the events in early retirement to have a disproportionate effect on the sustainability of an income strategy. We simulate failure rates if today’s bond rates return to their historical average after either 5 or 10 years and find that failure rates are much higher (18% and 32%, respectively for a 50% stock allocation) than many retirees may be willing to accept.

The success of the 4% rule in the U.S. may be an historical anomaly, and clients may wish to consider their retirement income strategies more broadly than relying solely on systematic withdrawals from a volatile portfolio.

As Pfau (2010) showed, the success of the 4% rule is partly an anomaly of the US historical data. In most other countries sustainable initial withdrawal rates fell below 4%. We find there is nothing inherently safe about the 4% rule. When withdrawing from a portfolio of volatile assets, surprises may happen. This study demonstrates that when we recalibrate our assumptions for Monte Carlo simulations to the current market conditions facing retirees, the 4% rule is anything but safe.

We also show that a 2.5% real withdrawal rate will result in an estimated 30 year failure rate of 10 percent.  Few clients will be satisfied spending such a small amount in retirement.  It is possible to boost optimal withdrawal rates by incorporating assets that provide a mortality credit and longevity protection.  Pfau (2013), for example, estimates that combining stocks with single premium immediate annuities, rather than bonds, provides an opportunity for clients to jointly achieve goals related both to meeting desired lifestyle spending, and to preserving a larger reserve of financial assets. In the absence of some added income protection, there is a high likelihood that low yields will require planners to rethink the safety of a traditional investment-based retirement income plan.

Junk Bonds’ Fire Is Poised To Fade

Junk Bond Yields Peaked

See Full Image At WS Journal

Is this a sign of peak low rates? Junk Bonds, the highest risk/ highest yield segment of the bond market, has been on a tear over the last year, and those gains (price increase/ yield decrease) roared on in the first days of 2013.

Bond yields have been marching steadily down- the chart on the left shows the prices rising up up up.

One has to ask, in this marketplace of compressed yield and increased frothiness, why jump into a junk credit yielding 5% when you can lock in a 5+% yield from  the likes of Met Life, NY Life, or Allstate?

These are companies with rock solid credit ratings, hundreds of years of operating history, massive reserves, and solid operations…

If you’re a buyer of junk bonds, you are either buying with an intent to hold to maturity, or you’re buying in full knowledge that you will likely loose money when you go to sell.  If you’re not aware of these two distinct possibilities, then perhaps the junk market is not the right place to be now?

Take another at the high yield but SAFE investment in the form of Secondary Market Annuities – a great fixed income alternative.

Of course, if you’re interested, give us a call.

The original WSJ article is here.

 

A Happy New Year? Not For Bonds

WSJ bond prices chartA recent Wall Street Journal article highlighted the Russian Roulette investors are playing in the bond markets.  The slightest upward tweaks in interest rates sends bond prices falling… and when prices fall, you lose money if you have to sell.  Bond buyers nowadays need to be making a ‘yield to maturity’ play, and plan on holding whatever they buy for the duration.

Case in point:

In the first two days of the year, prices for the benchmark 10-year Treasury have tumbled, sending the yield above 1.9% intraday Thursday, the highest level in eight months.

The article continues along with this intriguing piece:

The sudden moves have put investors and analysts on guard. Some are beginning to question whether Treasury yields, which have been stuck between about 1.60% and 1.80% for the past six months, may kick higher. Some wonder if they may even soon surpass 2%, a level they haven’t breached since last April. Many investors have been reluctant to bet against long-term Treasurys, in large part because the Fed has been such a big buyer of the debt and because intermittent shocks over the past few years—from worries about the U.S. economy to Europe’s debt crisis and troubles in the Middle East—have consistently sent investors scurrying to Treasurys for safety.

That has helped propel the bull market in Treasurys into a third decade.

Read that carefully- the FED is the largest buyer of the Treasury debt, keeping the rates artificially low and stable, and propelling a bull market in treasuries into a third decade.

Snake, eating its own tail?  How long can the charade last?

In a totally unrelated section of the paper, Rich Karlgaard, an excellent write at Forbes, had a WSJ editorial about Ponzi schemes.  He focused on Herbalife, but I suspect his keen and penetrating intellect could rip the Fed/Treasury farce apart.  We might not like what he has to say however.

Read Rich’s article here- it’s good.
A Short Seller Takes on a Vitamin Vendor

 

Muni Bond Tax Breaks On The Table In Cliff Talks

Taxes Lost  To Muni Bonds

Taxes Lost To Muni Bonds

 

In a stunning turn of  tables, even the tax-free nature of muni-bonds are on the chopping block in  our current buget turmoil.

Many of our readers are heavily invested in Munis so this article wil lsurely be important, interesting and relevant.

Here’s the Source:

And here’s a key summary:

By exempting municipal bond interest from federal taxes, the government creates an incentive for investors to buy them, which helps hold down the borrowing costs of the states, cities and other entities that issue them. Curbing the exemption would likely reduce demand for the bond

Investors are willing to accept lower yields for municipal bonds because their interest income is exempt from federal income taxes and from taxes in the state in which the bonds were issued. In some high-tax areas, such as California, the bonds are also exempt from local income taxes.s, pushing those borrowing costs higher.

Annuities Allow For Higher Yields- Moshe Milevsky In The News Again

For once, the Wall Street journal has published an article that I agree with on the topic of annuities!

For years I’ve cringed as their “Buy and Hold Stocks and Bonds” tunnel vision routinely ignored or bashed annuities.

But today brings a good article that I agree with, advocating to create a guaranteed income floor  that will allow  you to take more risks elsewhere to chase higher yield (if you are so inclined).

It’s exactly the strategy I advocate with clients on this and our other websites.

Because it’s so unusual for the Journal, I’m going to quote it entirely below.  It appeared Here first.

Moshe Milevsky, one of our favorite writers on the guaranteed income landscape, features prominently as well.

For those concerned they might outlive their assets, annuities can provide a guaranteed income stream.

But for those who go this route, a big question remains: How should your annuities affect the rest of the portfolio?

 

In general, investing professionals say that putting part of one’s nest egg in annuities can open the door to taking on more stock-market risk, which in turn offers the possibility for more portfolio growth.

Matt Grove, a vice president at New York Life Insurance Co., who heads the company’s annuity business, says owning annuities can allow investors to increase their risk exposure in part because annuities are so different from conventional securities. For instance, there are types of annuities that provide a set monthly check for life and that are completely independent of the ups and downs of the stock market, he says. And mixing uncorrelated assets is a key strategy in managing portfolio risk, whether you are talking about annuities or simply diverse types of securities.

Brett Wollam, senior vice president at Fidelity Investments’ life-insurance unit, suggests retirees use income annuities along with Social Security and pensions to fund their essential expenses. When there are several sources of guaranteed income, retirees can invest more in products with growth potential than they might have otherwise, he says.

“Typically, investors are too conservatively invested” in retirement, Mr. Wollam says.

What’s Your Tolerance?
Fidelity Investments Life Insurance Co. sales manager Robert Cummings gives an example of a 60-year-old couple who changed a portfolio that was invested largely in cash to one with a 45% allocation to two annuities and a 28% allocation to equities. The couple weren’t knowledgeable about the stock market, but they knew longevity ran in their families and were concerned about inflation, says Mr. Cummings. “Both factors speak to the need for growth because of the time horizon they are planning for,” Mr. Cummings adds.

The couple’s annuities now include a $200,000 deferred-income annuity from New York Life with a $1,057 monthly payout starting in five years.

Of course, not all annuity purchasers should increase their exposure to stocks. To some degree, the decision depends on the investor’s risk tolerance and the types of annuities he or she owns. With variable annuities, the value of the contract can fluctuate with stock and bond prices. At the same time, fixed-payment annuities could involve risk if the issuer is on shaky ground, or if the annuity lacks automatic increases to protect against inflation.

In some cases, in fact, annuities may help an investor ratchet back too great a stock exposure.

Reduced Risk
At Steele Financial Solutions in Cherry Hill, N.J., Joel Steele recommended that a 61-year-old client with 100% of his portfolio in equities reduce his risk exposure and invest in deferred-income annuities. The client had booked some recent gains in stocks but was generally frustrated with the continuing ups and downs of the market, Mr. Steele says. Even with the recent gains, he adds, the client’s portfolio was only back where it had been 10 years earlier. The client also was anxious that his pension wouldn’t provide enough income for his wife in the event of his death.

At Mr. Steele’s recommendation, the client invested half of his assets in two deferred-income annuities with guaranteed monthly payouts starting in two and 15 years. Of the remainder, he has 17% in stocks and the rest in income-producing bond funds.

“He’s not completely out of the [stock] game, but he’s not going to be affected by any stock-market crash either,” Mr. Steele says. “We’re not talking about taking people out of the market,” he says of balancing deferred-income annuities and equities. “We’re just making sure they’re OK.”

Moshe Milevsky, an associate professor of finance in the Schulich School of Business at York University in Toronto, says that for income protection in later life, the best annuities are those that delay payments at least until the purchaser reaches his or her 80s. The payouts for these types of annuities tend to be bigger than for annuities whose payments start earlier, but many potential investors see the long wait as too much of a gamble.

Indeed, these products, generally referred to as advanced-life delayed annuities, or longevity insurance, have proved a hard sell for the insurance companies that offer them (see sidebar). But according to Mr. Milevsky, delayed payouts enable purchasers to allocate more of their portfolios to investments with higher growth potential, compared with purchasers of annuities that start their payouts within a few years.

Mr. Milevsky is also founder of QWeMA Group Inc., a developer of products for wealth management, investing and insurance, with a focus on retirement income planning. Based on algorithms that he has developed, the company, whose name is an acronym for Quantitative Wealth Management Analytics, recommends mixing longevity insurance and mutual funds as a strategy for protecting income in later life.

No Easy Money in Muni Bonds

Jason Zweig is usually a surly and negative financial commentator.   I can’t recall the last time one of his columns said much positive about any financial marketplace.  This week is no exception as he takes aim at Muni  bonds, which many of our clients considering Secondary Market Annuities also hold.

I guess his position makes sense for someone  going IN to Munis in this marketplace… yields are so low that you must plan on holding to maturity (at 1-2%…), as any uptick in rates will result in a loss of principal.

But for those holding good munis with an attractive yield not threatened by maturity or a call provision, just hold tight.

This may sound  funny coming from someone selling financial products that compete with Munis.  But the truth is, a good yield on a tax free asset is just worth keeping.  Without question.

But What About Secondary Market Annuities?

Now that said, some of our clients are invested in Munis that have good yields, but the bonds are coming due, or are callable.  For those situations, Secondary Market Annuities are a great  alternative or re position investment.

Take a Muni yielding 5% tax free- it might have been issued 5 or 10 years ago, and if you  hold such a gem, you bought it a long time ago.  Your friends though you were weird settling for such a super low return then…. but you look like a genius now as it’s that’s a GREAT  tax free yield.

But then say your bonds mature in 2013.  You know you have liquidation coming soon, and you have to replace the investment.  What can compete?

We have clients in this exact situation… and they are choosing Secondary Market Annuities with yields in the 5-6% range.

They are replacing the yield on their Muni portfolio, selling their bonds that have short maturities, and re positioning in the best way they can find now.

And I think it’s a great strategy.

***

Read Mr Zweig’s dour assessment of Munis here if you want.  As with most of his work, he’s negative and arrogant at the same time, but does make some good points.

The Riskiness Of Stocks- A Zvi Bodi Article

S+P Roller Coaster

S+P Roller Coaster

I read a recent series of questions and answers in reply to a timeless cover story in the Wall Street Journal on the riskiness of stocks.  The article, by Zvi Bodi, covers the essential teachings of Professor Paul Samuelson, who wrote extensively on risk.

The essence is this: flipping a coin has a 50% probability of heads with each toss.  Tossing  for years does not change your odds.  Likewise, stocks are risky at ANY given time- MANY given times has no effect on the risk at A given time.  In other words, your risk is high no matter what.

So while time does not mitigate your risk, other factors may, such as your human capital or earnings potential. However, the reverse is also true.  As you get older and your earnings power diminishes, or your number of remaining earning years declines, your risk tolerance should also decline.

There are many fundamental reasons for guaranteed income such as annuities, but the wisdom from these economists is perhaps the most compelling.  With every day in the markets you roll the dice.  How lucky do you feel today?

I’ll quote a personal highlight:

A safer way to build and protect retirement assets is to picture your goals as clearly as possible. Then pare things back to the basics. Figure out the bare-bones level of income you need and invest in products that guarantee it……. Use the rest of your investment money to build reserves to fund your aspirational goals.

This describes perfectly our approach to annuities and financial planning- identify your baseline needs first, and cover those guaranteed expenses with guaranteed income.  Then, optimize the rest.. as you see fit.

Below you will find the rest of the article.  My only complaint is that like it does not mention annuities anywhere, when they should be foremost in the discussions of low risk alternatives to the markets.  Especially our Secondary Market Annuities- for all the complicated strategy described below of laddered TIPS and zero-cost collars and such, the simple truth is that a 5 to 6% guaranteed effective rate of return over many years is a GREAT rate of return.  No matter who you ask, no matter what market periods you look at….

With the long term guaranteed yields we have available to you in mind, enjoy the rest of the article below.

Why Stocks Are Riskier Than You Think
Most people can get the money they need for retirement without gambling heavily on equities, say Zvi Bodie and Rachelle Taqqu

A growing sense of urgency is driving many investors to take reckless risks with their money.

Even though they experienced the hazards of stock ownership firsthand in 2008, investors are venturing back into equities again. They’ve been advised that there’s no other way to make up the losses they suffered—or meet their looming retirement requirements—and, not to worry, the risk of stocks diminishes the longer you hold them. The Federal Reserve, meanwhile, has announced that it intends to keep interest rates low through 2014—providing a powerful inducement to stay in stocks since bonds will probably generate unusually low returns.

The desire to get back what you lost is understandable. But, as behavioral economists have shown, it can also cloud your judgment and lead you to take more risk than you can handle.

Despite the assurances of the financial industry, stocks are always a risky investment, and the longer you hold them, the better your chances of getting blindsided by a downturn. The usual way of mitigating that risk, diversification, holds no guarantees, either—for the simple reason that investments don’t always move the way we want in relation to one another.

A safer way to build and protect retirement assets is to picture your goals as clearly as possible. Then pare things back to the basics. Figure out the bare-bones level of income you need and invest in products that guarantee it, such as inflation-protected bonds. Use the rest of your investment money to build reserves to fund your aspirational goals.

But when you’re aiming to meet your aspirational goals, there is a way to limit your downside risk—by using instruments that let you limit your losses at the cost of some upside potential. You can do this through direct purchases of options, or you can buy mutual funds that use complex hedging strategies. These funds aren’t as transparent as stocks, but their aim is to protect your money from disaster.

A Hard Look at Stocks
It may be hard to let go of the belief that buying and holding stocks is a sure-fire key to asset growth. But that’s because people have been lulled into thinking that long-term stock investing greatly reduces the risks. The truth is that stocks are risky no matter how long you hold them.

Yes, equities can be expected to produce a superior average return in comparison to safer investments. That’s as it should be, because the higher return compensates investors for taking the added risk. But this does not mean that stocks become less risky over long time horizons.

There are a number of different approaches that demonstrate why the conventional wisdom about stocks is wrong. One of them has to do with bear markets, which happen regularly; the long growth stretch that began in 1983 and lasted through the 1990s has not been the norm. And the longer you hold onto your stocks, the greater your chances of running into one of those downturns.

Even with the long boom, bonds outperformed stocks over the 30 years since the fall of 1981—delivering an average annual return of 11.5% vs. 10.8%, respectively—with less risk and less volatility than equities.

To prove their claim that stocks are not very risky in the long run, stock enthusiasts argue that stocks have beaten bonds for every 30-year period starting in 1861—except for the most recent one. But their evidence is much thinner than it appears: Since 1861, there have been only five non-overlapping 30-year periods! Statistically, that’s simply too few independent periods to justify the conventional conclusions.

What’s more, the idea that “stocks do well in the long run” isn’t a practical guideline for individuals. For one thing, the “long run” means something different to different people depending on their ages and goals—for some, it’s 10 years, for others 30. And while the odds of getting good stock performance over that time are good, the consequences of a downturn can be severe, depending on how steeply markets decline, how much you have in the market, and when the downturn hits in your lifetime.

If you’re expecting stocks to outperform, say, 70% of the time, you need to think about how much you stand to lose the other 30% of the time. It does not do you a lot of good to have 20 years of great performance, only to be trounced in a crash just before you retire.

The usual way of protecting a portfolio—through diversification—is sensible and advisable. But it’s hardly a guarantee. Diversification aims to provide stability by mixing up different classes of assets, which are expected to behave differently in different circumstances.

Yet the correlations it’s based on aren’t constant. Bonds and stocks have moved in opposite directions at times, but in other periods they have not. And foreign markets are growing less and less decoupled from the U.S. Recently, prices of assets as diverse as large-cap domestic stocks, emerging-market stocks, oil and gold have been fluctuating together rather than in counterpoint.

A Safer Strategy
What’s a better approach to building a portfolio? First, forget the idea of “catching up.” Most of us find loss so painful that we’re willing to go out on a limb just to recover what’s gone. We’re willing to take risks we’d normally avoid to recoup what we see as rightfully our own.

Instead, when you start by looking at your destination and focus on what you absolutely need, you protect yourself from missing your essentials if the market falls short. And you steel yourself against a blind obsession with recouping loss.

Separate your basic must-have needs from your aspirations or wants, and create an investment plan that guarantees the basics with inflation-protected, safe investments. You may be surprised at how much less you need than you want, but try hard to be honest with yourself. Then put any other investment dollars you have available each year into riskier vehicles to meet your aspirational goals.

Intuitive and straightforward as this approach may seem, it’s not commonly pursued by most investors and advisers. Assessing what’s really necessary takes time and reflection. Few people do it systematically, if at all.

Once you decide how much money you need for your basics, create a safety net to guarantee that you can cover them. That’s where securities that protect against inflation—such as TIPS and I bonds—come in. (Although many people include insured bank certificates of deposit in this mix, CDs don’t provide inflation protection.)

For the best safety net, put together a “ladder” of TIPS, held in tax-deferred or tax-exempt accounts. Figure out how much money you need each year, then invest in TIPS with maturities that match your future spending dates. Your plan won’t be perfect, of course: Your personal rate of inflation may not match the Consumer Price Index, taxes may intervene, and life happens. But don’t let the perfect be the enemy of the safest available choice.

Today’s low-interest-rate environment poses some difficult challenges even with a bare-bones safety net in place. Today, TIPS and I Bonds do not yield more than the rate of inflation. And many people are starting practically from scratch, whether because the market collapse set them back enormously, or because they have not managed saving much for retirement yet.

It’s impossible to generalize about every investor’s situation, but many households are probably facing the prospect of a very small safety net in retirement.

With that outcome in store, many people may be tempted to gamble on riskier investments to meet their retirement needs. But your safety net is meant to be the money you can count on. By definition, you don’t want to put it at risk. If you bet your basics in the market and lose, you can easily end up worse off, with less to spend on your essentials.

If you don’t think you can create a safety net that’s big enough, there are other steps you can consider, although they can be tough. You might spend less today to save more for tomorrow. You might work extra jobs, move to a higher-paying career or retire later. You can also try scaling back your definition of needs.

How low can you imagine turning down the jets if need be? Is a community college a viable alternative for your child’s first two years out of high school? Can you lower your expenses in retirement by moving to a less-expensive location, downsizing your residence or traveling less?

It’s this kind of assessment that should be driving your risk decisions. It requires careful and honest introspection, as well as a lot of consulting with the key partners in your life.

Limiting Your Risk
Now that you’ve separated your needs from your wants, you can decide how much to limit the risk you take with your aspirational investments. If you’ve lived through 2008, you probably don’t want to see losses of 30% to 40% ever again.

There are several ways to protect the money outside your safety net. For instance, there are investment products that protect either principal or income by using hedging strategies involving various combinations of derivatives.

But you must be careful to read the fine print. You need to understand the managers’ strategy in detail, including which risks they’re hedging and which risks remain unhedged. It’s also important to weigh a fund’s expenses, both embedded and explicit. The costs of these transactions can be high, so do look carefully at the expense ratios of the fund along with all its fees.

Investors who are more seasoned can undertake some of these complex strategies on their own. For instance, when you buy an investment such as the S&P 500, you can buy a put option on it, too. This gives you the right (but not the obligation) to sell the investment at a future date at a price you determine at the time of purchase. Since your investment can’t fall further than the “strike price” you’ve selected, you’re effectively setting a floor on your losses.

Let’s say you buy SPY, an ETF that tracks Standard & Poor’s 500-stock index, at its recent price of $136.41. You’re willing to sustain a 15% loss, but not more, so you buy a put with a strike price of $116. Since you can now sell SPY at $116, you’re protected in case it drops any lower. Essentially, you have bought insurance with a deductible of 15%; that’s all you can lose.

Is it worth it? The put in this example, which expires in four months, would have cost $2.16 at the time you priced and bought your ETF shares. But the good news is that there is a way to avoid the cost of the put, by trading away some of the upside of your SPY shares. You can sell a call on your investment. This means that you are selling someone else the right to buy it at a stated strike price on or before a future date. If the shares reach the strike price, you are obligated to sell.

In order to end up with a near-zero cost for your options, the prices of the put and the call will have to be roughly the same. In our example, there is a four-month call that is priced at $2.17—close to the $2.16 you paid for your put—and it has a strike price of $143.

When you sell this call, your proceeds fully offset the cost of your put. If the value of the ETF rises before the option expires, you get to keep everything up to $143. But not more than that: Your gains beyond $143 have been traded away. So the strike price of the call you sell is the upper bound on your potential gain.

In this strategy, called a zero-cost collar, your costs are limited to your transaction costs alone, since your proceeds from selling the calls will zero out the cost of the puts. And your investment outcomes are now limited as well: In this case, you can’t lose more than 15% on the downside or gain more than 6% on the upside.

If you want to increase your potential upside and still have the costs cancel out, you’ll need to lower your floor. In our example, you can increase your potential gains to $147 if you are willing to take losses all the way to a lower threshold of $108 (that’s a loss of just over 20%). It’s akin to increasing your deductible on insurance in exchange for a reduction in the premium you pay.

For the most part, “structured” products for limiting risk are still on the drawing table. They remain to be perfected. But the notion of sacrificing a limited amount of safety in exchange for upside potential is profoundly relevant to retail investors’ needs right now.

So keep your eye out for them: It should not be long before growing consumer demand transforms them from next-generation investments into products whose time has come.

Good News- The USA Is A-OK

We spend so much time reading bad news- think  national debt, entitlement reform, inflation, deflation, de-leveraging, low rates, and foreign threats- that we forget that the US is an incredibly dynamic and resilient place.

Our nation has survived a lot of lumps, and while we sure have some tough sledding in the decades ahead to get our debts and promises back in line with our means, there is good reason to believe that not only is that achievable, but our means are also likely to increase.

So today’s article is a ray of sunshine from one of my favorite big thinkers, Rich Karlgaard, Publisher of Forbes.  The title of the Wall Street Journal article is “The Future Is More Than Facebook” and it appeared in this 5/17/12 edition of The Journal.

The article makes the point that with Facebook’s IPO, we’re at the end of an era in Silicon Valley, and poised for a new wave of innovation. Now, Silicon Valley cycles are a lot like dog years, so the next big thing will be old news in 18 months or so, but that’s another story.

The point today is that social networking is a dynamo that did not exist a decade ago- billions and billions of dollars of value were created out of nothing, in a decade.  And it was  a pretty bad decade for the rest of the stock markets.  New waves of innovation in the years ahead will create new billionaires and these new, massive upheavals will sustain our preeminence.

Some really well said points are below:

The debate about whether America will own the global economy in the 21st century or else become a dude ranch for rich Chinese and Brazilians hinges on whether innovation can break out of the box. Can it go mainstream and transform the really big things: transportation, energy, electricity, food production, water delivery, health care and education?

If it can’t do that—or if it is thwarted by high taxes and complex regulation—then welcome to the new normal of 2% annual growth. Our future will become sadly familiar. Just follow Spain, France and Great Britain down history’s sinkhole of lost status and influence.

Despite this alarming warning, Karlgaard takes the high ground and gives a compelling vision of what the wealth, innovation, and capital of our country can accomplish when applied to the big problems of our world.  He continues:

Manufacturing? America will own the mid-21st century. Geopolitical instability and rising oil prices will wreck the late 20th-century rationale for outsourcing. Chinese labor costs are rising 20% a year while robotic costs are dropping by 30% a year. Do the math.

“Made in the USA” is set to have a major comeback. The showstopper will be 3-D printing, which makes physical objects from a digital file. It will turn our artists into artisanal manufacturers and reward American-style creativity.

Energy? America’s natural-gas and shale oil boom will bridge us to 2030 or so when solar energy and algae-based fuels will be closer to market parity and begin to make a real contribution. One of the companies who are making the use of solar energy grow across the country is Sandbar Solar & Electric. As long as I’m on the topic of the natural-gas boom, what key technology made this happy surprise possible? High-tech horizontal drilling. Who knew? We were all too busy fiddling with our iPhone apps to see it coming.

Question: If America could have only one of the following—Facebook, Twitter or horizontal drilling—which would be the smarter choice?

Happily, we don’t have to make that choice. America remains the world’s innovator, a country without limits.

Wow– I sat up straight and saluted at this.  What a refreshing vision of what can be.  Thanks Rich!

What Do you think? Tell Us Your Thoughts Below…

Re-Sale of Pension Income- Wall Street Journal

A recent article in the Wall Street Journal revealed another secondary marketplace- that of secondary pension re-sales.

This is a relatively new but growing industry that seems to be skating a fine line of laws.  It's our understanding that ERISA- the laws that govern pensions- prohibit this sort of transaction.  We're not experienced in this marketplace and of course would recommend any reader to proceed with caution.  Please let us know your experience and we welcome any comments or discussion below.

A U.S. Senate committee is considering tackling a burgeoning and controversial business in which veterans and other retirees sell some of their future pension income to investors, with an array of middlemen profiting from the transactions.

"The sale of pensions to investors in secondary markets is a worrisome new practice that deserves careful scrutiny," said Sen. Tom Harkin, chairman of the Health, Education, Labor and Pensions Committee. "In tough economic times, hard-working people are often forced to make difficult choices between immediate economic needs and their future retirement security.

"However, it is critically important that people forced to make these tough decisions have the information they need to make wise choices, and don't fall victim to unscrupulous or illegal practices."

Mr. Harkin, a Democrat from Iowa, said he plans "to take a closer look at these issues in the coming months to ensure that our laws are respected and pension participants are not abused." A committee spokeswoman said it is early in the process, and the senator declined to elaborate on possible courses of action.

As The Wall Street Journal detailed in a story earlier this month, financial middlemen have helped to set up websites with names such as BuyYourPension.com and pension4cash.com to connect pension recipients.

The pensioners need immediate cash; the investors are lured by promises of higher returns.

The market plays off several current trends: With tougher credit standards, many people who ordinarily might borrow from credit cards are willing to pledge future pension checks for cash now, even if the terms are highly unfavorable to them.

Many people who never previously considered unconventional investments are attracted to them with bonds paying ultralow yields and stock markets a highly risky bet.

The financial middlemen bundle information obtained by the websites into spreadsheets that are supplied to financial advisers for their clients. The investor pays an agreed-upon lump sum to the retiree, who signs a contract pledging to hand over all or part of each month's check for a set number of years. The deals typically are priced to yield investors 6% to 7% or so a year, as their money is returned over a period of several years to 10 years.

Meanwhile, an array of middlemen collect fees: They are spread among the website operators, firms that do the heavy lifting of pulling together transactions, distributors and the financial advisers who land individual investors.

No one keeps track of how many pensions are traded for instance cash, and the number for now is believed to be small. But in recent months, websites have proliferated, and middlemen far from Wall Street have ramped up efforts to win over financial advisers to the concept.

These firms have their eye on the hundreds of thousands of military veterans, police officers and firefighters who can start receiving pension checks while they are still in their 40s, many of whom have moved on to other jobs and wouldn't be put in desperate financial straits if they pledge some of their future pension income for a wad of cash.

The deals attempt to thread the needle of federal pension law and federal statutes governing military pay, which prohibit the "assignment" of qualified pensions. The transactions attempt to make the distinction that the pension itself isn't being assigned but that the retiree is promising to fulfill a contract and will use money he or she has received from a pension check.

But that makes the transactions risky to investors because the retiree could breach the contract or file for bankruptcy, putting investors in a line of creditors seeking to be repaid.

Pension-income-stream transactions arranged by a California firm that has been in the business since the 1990s have been enforced by some courts but rejected by others, including a U.S. bankruptcy court, filings show.

Source: WSJ

Federally Issued Inflation Adjusted Annuity

indexMy mind was filled with negative images before I even got the details of the plan covered in this New York Times Op-ed. The article rightfully acknowledges the high risk many people face of outliving retirement assets but the solution causes all sorts of problems.

Yes, the authors do in fact believe that a federally issued inflation adjusted annuity is the answer to the challenge of longevity risk. In my opinion this is an extremely reckless proposal for several reasons.

Here are my thoughts based on what’s mentioned in the article.

First, it is stated that there is no single financial product capable of dealing with longevity risk. That’s news to me since insurance companies, as I understand, have been properly managing assets for retirement income for several centuries now. The authors do note that private annuities go part of the way to address the problem. If they don’t go all the way it’s a funding issue and no fault of the annuity product itself.

Next, and I quote, “By doing good for individuals, the federal government could actually do well for itself.” The problem here is that the government always does well for itself. Congresses past have helped themselves to the social security trust fund and that is a critical reason why that fund is costing taxpayers so much money and is projected to go insolvent in less than 30 years. The fox is already guarding the henhouse. Why would we put more chickens in there?

Also, the article mentions the risk of potential insolvency of insurance company and states that the fed is well-equipped to carry the liability instead. Again, I’ll quote.

“…how can someone — particularly a young person — know for sure which insurance companies will be solvent half a century from now?”

How indeed? Well, I don’t know, except for the fact that the federal government is already over budget and deeply in debt. Insurance companies, on the other hand, are solvent, profitable and suitably hedged for future obligations. If I were looking for a good steward for my money, I’d rather have a hole in my head than trust more of my financial well being to those spend-happy egotists in D.C.

Lastly, when you look at how the proposal would be structured it’s no different than current annuity contracts. It’s like these guys just realized what annuities are designed to do and figured that the government should get in the business. Sorry guys, your idea is a couple hundred years behind its time. Any notion to the thought that the federal government could achieve better results than insurance companies cannot be grounded in actuarial analysis. Do the American public a favor and run some numbers to assert these claims.

At a time when social security is projected to account for nearly 40% of retirement income for the average individual, the last thing that should happen is to ensure more private money to that public institution. Does anyone remember Enron? So many employees got hurt because they were banking on Enron pensions, planning on cashing out Enron stock options and had 401(k)s heavily invested in Enron stock. That’s a direct example of how the lack of diversification put millionaires on food stamps. How is this proposed strategy an less risky?

Annuities work as designed and no meddling from bureaucrats will improve the situation. The reason I’m citing this article is to illustrate the fact that you can’t count on anyone but yourself for long-term financial security.

If you feel so inspired, I would love to have some comments or questions on this post. Please… tell me what you think!

Bryan J. Anderson
800.438.5121 [email protected]

 

State Budgets: Day of Reckoning…60 Minutes Excerpt

Is a new fiscal crisis looming?  The Dec. 19, 2010 episode of 60 Minutes offered a chilling report of how individual state budget issues present a pending challenge to financial markets.  A portion of that broadcast is shown below.

Some of you may have already seen this and if so, it’s probably worth watching again.  We all should be aware of the serious budget issues the federal government is facing but threat of default from state and municipalities is every bit as real and potentially harmful.

After years of overspending and inflated promises, the day of reckoning is at hand.  How will the different government agencies deal with the problem?  More importantly, what effect will all of this have on you?

Whether or not this all comes to a head in the near future, legitimate solutions are likely to cause higher taxes, lower benefits and/or increased volatility.  Contact the experts at Annuity Straight Talk for a serious discussion about taking precautionary steps toward asset protection.  800.438.5121

Is an Earthquake More Predictable Than A Financial Disaster?

It was interesting to learn that a natural disaster is more predictable than financial disaster.  With this kind of analysis there is a very good lesson to be learned in this Yahoo Finance article, written by Jack Guttentag in May 2010.   Read the Article (OOPS! Link Dead!) here

In the case of natural disasters, advances in science and technology have allowed for enhanced detection of early warning signs. The author notes that in the case of Mount St. Helens, seismic testing showed early warning signs that led to restrictions on the area and limited the loss of life as a result.

The capacity to do the same for financial disasters is non-existent.  It’s true that some people see pressure mounting in financial markets and are able to escape the fallout. But warning the masses to do the same is difficult because contradicting information or opinion may be just as compelling.

In the author’s words…

Underlying financial disasters, in other words, are malefactors who profit from the activities that lead to disaster, obstruct any efforts to restrict these activities, and attempt to shift the cost of the disaster to others. There is no counterpart in natural disasters.

Contagion theory describes two major drivers contributing to the extent of damage to which victims of a disaster are exposed.

Positive Contagion increases participation in a high-risk activity based on the social influence of other people.  This leads to a much greater negative impact on victims in relation to both financial and natural disasters.

Here’s a good example from the author…

Consider home buyers deciding whether or not to move onto an attractive flood plain that over a long period has averaged a devastating flood every 50 years. The probability that a flood will occur in any one year is thus about 2%. Based on experience over many such situations, we know that after some years pass without a flood, people will begin to move in. The longer the period without a flood, the more people behave as if the likelihood of one has gone down, though there is no rational basis for this belief.

This behavior is reinforced by positive contagion — the fact that some have done it successfully encourages others to follow.

The perceptual bias in the buildup to a financial disaster is even more powerful. Consider mortgage lenders who can make a lot of money writing loans for subprime borrowers so long as home prices continue to rise at a rate that is twice the long-term average. The longer the high rate of appreciation continues, the more lenders jump in the game, as if the longer period increases the likelihood that the price bubble will go on indefinitely. Yet the reality is that the longer the above-normal rate of price appreciation continues, the closer is the date when the bubble must burst. Positive contagion plays a role here, too – WAMU is making a lot of money in this market, why not us?

Contrast Positive Contagion with Negative Contagion:

Negative Contagion causes people to react to a disaster out of fear in an attempt to escape the undesirable consequences. This behavioral characteristic exacerbates damage during financial disasters whereas destruction from natural disasters is limited by nature.

Mr. Guttentag describes it like this:

…positive contagion arises in the buildup to both natural and financial disasters, but negative contagion arises only in connection with financial disasters. The scope of natural disasters – how extensive, widespread and long-lasting they are — is determined by nature, but the scope of financial disasters is expansible through negative contagion. Fear is perhaps the most contagious of human emotions.
A financial disaster involves a loss of confidence in the ability of one or more major players to meet their obligations. In the bank crises that occurred during the 19th century and through the great depression of the 1930s, the loss of confidence was largely limited to commercial banks and their ability to repay depositors. Contagion resulted in bank runs, which could jump from one bank to another, often with little discrimination.
In contrast, runs during the recent crisis involved withdrawals from money market mutual funds holding commercial paper, and refusals by investors to roll over maturing repurchase agreements and commercial paper. All three types of runs were stopped by early and resolute actions by the Federal Reserve. Otherwise, the crisis would have spiraled out of control.

How does this relate to you and your behavior towards appropriate retirement planning?

To some extent, all people have the ability to take action to mitigate the impact of a financial disaster. Whether it’s paying off a mortgage, protecting assets from tax increases and market volatility or securing a source of future guaranteed income, there are options available to protect yourself from an unforeseen crisis.

Several analysts are putting forth compelling data suggesting another crisis is looming. But then again, there is just as compelling information to the contrary.  No one really KNOWS for sure what will happen or when.

The most important thing is to be prepared for what comes, regardless of the timing or the potential extent of the damage. I learned that in my days as a Boy Scout and it’s a lesson as powerful as it simple.

Please, give some thought as to how Contagion Theory has affected your investment experiences in the past.

Hindsight is 20/20- are you taking a focused look back at what you did (or did not do) in prior financial downturns or bubbles?  Are you applying it today?

Likely, we have all bought and paid for some expensive lessons with our nest egg.

Now, I am not advocating trying to time the market, or saying that any particular advisor can avoid all emotion and make winning trades in every market.

Rather, I am advocating that you put in place protective measures to ensure that you are making wise decisions and taking into account appropriate risks.  This is totally individual- no one size fits all, and each situation is different.

When you’re ready to take protective action against the forces you cannot control , call Annuity Straight Talk toll free, send an email or make an appointment.  We stand ready to assist.

Federal Budget | What is $100 Million Dollars?

This YouTube video graphically illustrates just how massive our budget deficit problems are.

It is almost impossible to understand how large and intractable our budget issues have become. This is a start.  This may also be a start to a series of posts on this site on the issues we are facing.

Retirees attempting to plan for stable retirement income and golden years must start to understand these issues and plan accordingly.  Guarantees and tax deferral play an integral role in countering the effects of runaway federal spending, and can help lock in the security you need.

Will This Rally Last?

Happy New Year everyone!  It looks as though it’s time to get back to work after the holidays so I’m going to tackle a subject that seems to be creating some debate recently.

The stock market has been on an impressive run over the past couple of years causing many people to shed the apprehensions that followed a disastrous 2008.

Which side of the fence are you on?  Is this rally the real deal.  Since most investors are cheering the market’s run I want to remind people not to get too excited.  Brett Arends of the WSJ talks about this “Santa Rally” at length in a recent column.  Read Brett’s article here…

The article presents several good reasons why it may be a good idea to take some chips off the table and protect your gains.  It’s the difference between a big mistake and a little mistake.  Do you want to continue to carry high risk or protect your assets?  The market is at it’s highest level in two years and although economic conditions seem to be improving, we still have several lingering problems that can end the party in a hurry.

Whatever happens is entirely your choice and the big disclaimer here is that I’ve always been conservative with investments.

Call or email anytime for a honest discussion of how safe investment vehicles, such as annuities, hold pace with other assets through all the up and down years.  Do you want to worry about your money disappearing or not?

Best Wishes For a Prosperous 2011!!!

Bryan J. Anderson

800.438.5121 [email protected]

Positive Economic Indicators

How about a little good news this week?

Since we are well into the holiday season, I figured it was a good time to share some positive information with all members of Annuity Straight Talk.

Again, I’d like to direct your attention to the WealthVest blog for a report from the Conference Board on leading economic indicators.  There is good reason to relax a little this holiday season as this report shows the economic recovery is gaining momentum.  Read the report here…

After all that’s happened financially in the past two years, we have good reason to be thankful that America has shown great resiliency since the 2008 market collapse.

Regardless of what the future holds, it’s time to celebrate the end of 2010 with family and take a well-deserved rest from the turmoil of the past.

Next week we’ll begin to focus on what the future holds and how to prepare for it.

Bryan J. Anderson

Wishing you a very Merry Christmas!

No Time Like Now To Talk Taxes

How about we take slight break from Annuities this week and get down to something that affects every aspect of our financial lives.

From the Wall Street Journal comes this article titled “Smart Year-End Tax Moves.”

Since big changes to tax law are on the horizon, it may be a good idea to make sure you have time to act in case the changes could adversely affect your personal situation.

Yes, the debate on the extension of the Bush-Era tax cuts is at the center of this coming storm but everyone needs to understand that failure to stop the expiration will impact more than just the top income earners.

All income tax rates will rise without an extension and most concerning of all, the dividend tax rate will increase from 15% to 20%.  Now I’m certain that will have an effect on anyone currently saving for retirement.

Take a look at this worthwhile article and be sure you have time to make changes if needed.  As always, call or email with questions or comments and have a great week!

Bryan J. Anderson

800.438.5121 [email protected]