Earlier this year I wrote 3 Financial Products to Consider Avoiding. This was not intended to be a complete list so here are three more financial products to consider avoiding.
High Cost Variable Annuities
Though I’m not a huge fan of variable annuities, my issue is not with the product but rather with the high fees associated with far too many of the variable annuities sold in the market place. A variable annuity generally entails a lump-sum or a series of investments into sub-accounts, which are somewhat like mutual funds. There are equity sub-accounts, bond sub-accounts, and so on.
Variable annuities are contracts offered by insurance companies. After an accumulation period the insurance company guarantees a minimum payment which can vary based upon the withdrawal term (single life, joint life, period certain, or others). Alternatively the owner can choose to take the payment as a lump-sum or as needed over time, in this case there is not insurance company guarantee.
The expenses generally include an expense ratio for the various investment sub-accounts plus insurance expenses called mortality and expense charges. These are the fees collected by the insurance company in exchange for their guarantee of a payment later on. Some VA contracts also include surrender charges by which the insurance company penalizes you for withdrawing your money before the passage of a set number of years. The surrender charge usually declines over the surrender period.
I’ve seen contracts with annual expenses well over two percent. In my mind this is beyond outrageous and really eats into your ability to accumulate money for retirement. Contrast this with a low-fee (and no surrender cost) option like Vanguard where the expenses are generally about 1/3 as much. Believe me your insurance agent or registered rep isn’t going to show an option like Vanguard or other similar low-cost, no surrender fee providers.
A number of ETFs use derivatives and other devices to amplify the performance of the underlying index, such as the S&P 500. There are ETFs that seek to provide 2 or even 3 times the return of their index both long and short (inverse). Again here there is nothing inherently wrong with these ETFs as a product, but my reason for including them is that they are not appropriate for most investors in my opinion. They are wonderful when the market is moving in the right direction and things are clipping along well. But when the market turns in the other direction and the negative returns are magnified 2 or 3 times, your losses can really mount. Additionally these levered ETFs do not track the index that well on a longer-term basis, they are generally designed to follow the daily changes. These can be great vehicles for professional traders and money managers, again in my opinion they are too risky for most individual investors.
Technically this is not a financial product, but rather a type of account. Self-directed IRAs are offered by a number of custodians and are accounts that allow investment in a number of alternative investment vehicles that are prohibited by more traditional custodians.
In a July 12, 2012 article USA Today columnist John Waggoner said of self-directed IRAs: “Just because you can do something doesn’t mean that you should. You may be perfectly capable of cross-breeding trout with electric eels, for example, but you probably shouldn’t do it unless you’re very angry at fishermen. You can invest in a wide array of things via your individual retirement account, aside from the usual stocks, bonds and mutual funds. Office buildings? Sure. Small businesses? Check. Unregistered securities? Yep. And you can invest in all of these through self-directed IRAs. Should you? For most people, no. But for a few people, it can make sense.”
There are certainly legitimate providers and custodians of these accounts. For some investors this might be a legitimate route to go. For most investors, in my opinion, this is a slippery slope at best. Real estate investments in your IRA, do you not remember the recent financial crisis? Using your IRA to fund a business? While no businessman starts a business thinking about failure it is a reality. If you use your IRA to fund a business and it fails, you now have a failed business and no retirement account.
Let’s use some common sense folks. Don’t be swayed by the hype of most of the folks peddling these accounts and the allure of the sometimes exotic investments that often are used to fund these accounts.
Please feel free to contact me with your financial planning and investing questions or to discuss your retirement planning options.
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