Why Annuities Are a Garbage Investment
The market has been a mess since the beginning of 2022. We got a bit of a reprieve early in 2023, though it was mostly top technology stocks like Alphabet (Nasdaq: GOOGL) and Amazon (Nasdaq: AMZN) that did the heavy lifting for the major indexes. Most other stocks are down on the year.
On top of that, every single day, one of our leaders in Washington does or says something so stupid you wonder how they’re able to dress themself in the morning, much less hold a position of power.
It feels like things are spinning out of control.
And when that happens, you can count on the annuity industry to ramp up its marketing and try to convince you that it’ll make everything alright.
I’ve written extensively about annuities and what terrible investments most of them are. In fact, in my book You Don’t Have to Drive an Uber in Retirement, Chapter 16 is titled “The Worst Investment You Can Make.” It’s about annuities.
Whenever I write a scathing review of annuities, the annuities salespeople put me on blast. But the numbers simply don’t add up.
An annuity provides an income stream that is based on how much the customer invests and other factors. Fixed annuities, which pay a set amount, are the best (though that’s not saying much), as they are usually the cheapest. Variable annuities, whose returns are tied to the stock market or another variable, are usually very expensive. They are pitched to investors as a way to participate in market upside with limited or no downside.
Sounds great, right? Not so fast.
First of all, your upside is usually capped. For example, you may be guaranteed not to lose money if the market goes down, but your gains might be capped at 8% if the market goes up. So even if it’s a strong year and the market goes up 20%, you’ll make 8%.
There’s no such thing as a free lunch on Wall Street. You’re not going to get unlimited upside with little to no downside, especially at a low cost.
The annual fees for annuities typically run between 1% and 3% of your initial investment. So if you own an annuity for 20 years and your fee is at the midpoint of that range, you’ll pay 40% of your capital in fees.
Annuities also often come with steep commissions. Depending on the annuity, you’ll pay anywhere from 1% to 8% in commission fees. So if your fee is at the midpoint of that range and you have $100,000 in capital, only $95,500 of it will actually be invested, because $4,500 will go to the agent who sold you the product.
But really, here’s all you need to know about annuities…
In 2016, the Department of Labor passed a rule that designated all financial advisors as fiduciaries, which meant they were required by law to do whatever was in the best interest of their clients. After that rule was passed, annuity sales fell 8% in 2016, including 16% in the fourth quarter. Sales of variable annuities, the worst of the worst, dropped 22%.
In other words, once advisors realized they could get in trouble for selling this garbage, they stopped trying.
But then, in 2018, the Trump administration killed the rule – and annuity sales soared 40% in the fourth quarter.
Once the government removed the consequences for selling products that were not in clients’ best interests, advisors hit the phones hard.
According to Bloomberg, investors in an S&P 500-linked annuity would have missed out on $54,000 in profits per $100,000 invested over a 10-year period. That is a significant amount of money.
Lastly, most annuities have strict rules about cashing out early. You’ll pay dearly if you want your money before the contract is up.
So what’s an investor to do in these uncertain times?
The best thing you can do when the market is down is buy stocks.
It’s not easy to do. It’s scary. And when the market keeps going lower, it can be stressful.
But we know that markets go up over the long term and that anyone who has bought during a bear market has made money. They may not have been in the green the following day, month or even year. But they most definitely were within a few years.
So here’s what I recommend: Instead of buying an annuity, take a meaningful amount of capital and buy Treasurys or investment-grade corporate bonds. They are extremely safe and will generate income for you.
Take another chunk of capital and invest it in Perpetual Dividend Raisers, stocks that raise their dividends every year. That will help you generate even more income each year. And as interest rates fall and your high-yielding bonds are replaced by lower-yielding ones, Perpetual Dividend Raisers will help you make up that ground.
Perpetual Dividend Raisers also tend to be safer than other stocks because they generate a meaningful amount of cash flow that usually grows each year. That should help the stock portion of your portfolio increase in value as time goes on.
Annuity salespeople will seize on the chaotic state of the market and the country. They’ll offer to provide stability and reliable income. But they’ll neglect to mention that you’ll pay a fortune and won’t have access to your capital should you need it.
The beauty of a curvy road through forests, without intersections. Note: This is a November 2023 update of a…