Clark Howard is known as “a nationally syndicated consumer advocate who advises consumers how to save more, spend less and avoid getting ripped off.” He wrote this recently about variable annuities:
To pay for investment advice or to get it “free”?
It’s possible today to buy investments that have ongoing costs of a mere one-sixtieth what you pay ongoing in a variable annuity. Variable annuities are by far the most popular product that insurance salespeople will try to sell you when you go to them for financial advice.
But variable annuities are garbage. They have huge expenses; big fees if you try to bag out before a certain point; and massive tax problems compared to other ways you can invest. But that’s what you’ll probably be steered to by a commissioned insurance salesperson.
So remember this: Paying people to guide you is money well spent, not money spent poorly. If you are at a roadblock or you don’t know where to start, hire a fee-only financial planner and pay them for guidance. “Free advice” that comes from commissioned salespeople is hazardous to your wallet.
If your “investment advisor” recommends variable annuities try paying for your advice instead of getting it “free.” You deserve a fiduciary standard of care.
Sweeping generalizations of a particular insurance product is as simple as Suze Orman sloganeering. Annuities are complex, especially variable ones. If your advisor can’t explain the intricacies of a variable annuity strategy with riders attached, and how it may or may not fit within your investment/income/retirement strategy, he isn’t worth his salt. Income benefit riders, for example, are the only way for a conservative investor to have market exposure while limiting downside. The other method would be doing the same thing with Options, but you’re paying for premiums on that, along with the fee-based planning that that may involve (God forbid an average Joe try venturing into options successfully by himself. Many prefer to dump that risk on the shoulders of an insurance company.
David John Marotta
Doug, I couldn’t disagree more. If annuities are as complex as you suggest it is just another reason to avoid them. In our Safeguarding Your Money Series Safeguard #5 is Understand Your Investment Strategy: Certain responsibilities cannot be delegated to others. Understanding and maintaining your role in the process is critical to safeguarding your money and consequently your financial freedom.
DJM, for the most part I would agree with you but you are totally missing what Doug is saying about having an income for life no matter what happens in the market- with the possibility of catching the upside and locking in those higher market values. Values that can provide an even higher stream of income for life.
Also, I had a client who passed away in 2002 when his annuity value was almost half of what he started with. He had been using the monthly checks to supplement his pension and social security income and it fit his cash flow needs exactly. Unfortunately a hidden heart disease ended his life early. Luckily he had death benefit riders and he left his wife an almost 20 % gain on his original starting value.
Sadly his widowed wife passed in 2008. She lived nicely off the annuity income but saw her value drop significantly in the sub accounts. Her daughter received a death benefit of about 6% more then her mom received on her husbands death.
I’d say all those “expensive fees” saved this family from huge losses if the didn’t have these insurance riders.
David John Marotta
John Golen, you are making the point that there are cases where consumers buy variable annuities and they profit either from the investment or from the insurance portions of the riders. Agreed.
But you are neglecting to consider that there were better ways of getting those features without the variable annuity characteristics which make the product less desirable. The “expensive fees” did not save his family. In fact he could have had the same coverage for much less expense without using variable annuities!
The McDonald’s Double Quarter Pounder with Cheese (740 Calories, 42g of fat, 1380mg sodium) is garbage when compared to a healthier alternative. But if you eat it, it will still provide calories and sustain your life.
Ah…the VA. Both loved and loathed by millions. I seldom, and I mean seldom, use the VA but I do find there are niche situations where the VA provides benefits that can’t be replicated with traditional securities…especially in an ultra-low interest rate environment. I’ve lost count on how many studies I’ve read about the benefits, the features, the pitfalls,and the problems of VAs. But I’m likely to be skeptical of the person who is so willing to announce that something is good for all situations or conversely bad for all situations as Mr. Howard is clearly doing. Dealing in absolutes about any product, any investment or any strategy seems like a set up for disappointment.
David, you indicated there are alternate strategies that offer “better ways of getting those features…” without having to deposit money into a VA. What would your top two or three strategies be?
David John Marotta
Obviously it all depends on what a client’s goals are and putting those goals in the form of life-goals not financial features. When put in the form of life-goals concerns such as the possibility of an inflation black swan event have as important a place as market black swan events.
For the majority of clients seeking a comfortable retirement with withdrawal rates that keep up with inflation a regularly rebalanced and diversified portfolio with 5-7 years of spending in stable investments and the remainder in appreciating investments with low expense ratios along with safe annual withdrawal rates provides the best chances of weathering everything from market black swans to inflation black swans.
That commissioned agents rarely recommend this strategy and commonly substitute VAs with high fees and long lock-up periods shows a bias which I am willing to agree with Clark Howard makes the investments (generally) suspect. I would certainly want a second and a third opinion before believing that any annuity provided the best chance of meeting my life-goals.
Matthew Carbray, CFP
I do agree with a few of the comments, namely the high expense and confusing attributes given to variable annuities. As a hybrid financial planner (fee and commissionable products when appropriate), I find that the usage of an annuity in varying percentatges (often 15-25%), has often provided less portfolio strain in times of market volatility, i.e. the last 10 years. There was a study conducted by BlackRock not too long ago that provided multiple Monte Carol simulatons of different portfolio demographics (equity to fixed income) and withdrawal rates in retirement. What was concerning to me was that a 60/40 portfolio (often viewed as the portfolio that most closely sits on the efficient market frontier’s capital pricing line) had a 55% chance of not running out of money over a 30 year retirement. That 45% longevity risk is precisely why shifting the risk to an insurance company to some degree makes complete sense.
The average investor is not sophisticated enough to maintain a well diversified and constantly rebalanced portfolio to meet the income needs he/s she has in retirement. I am a believer in low cost index funds and no-load offerings like Fidelity and Vanguard, but neither of those solutions protect against an individual’s unwillingness to alter their income intentions in retirement because of poor market performance. An annuity, for those with the understanding of the contractual provisions and limited liquidity, can provide some structure.
Just my .02.
Matthew Carbray, CFP
David John Marotta
Greetings Matthew, I’ve looked at the papers suggesting that an allocation to variable annuities provides a better financial picture and they just don’t support that conclusion. Generally they claim that they are better than portfolios which are common but not optimal or they claim that they have higher income rates while losing site of the immediate 100% lost of principle it took to purchase them. I have yet to see the study that shows a variable annuity solution providing a better solution than alternative plans which seek to achieve the same goals without variable annuities.
My argument is that a portfolio with annuities is never on the efficient frontier. If nothing else, the high fees push it off optimal.
The “best” arguments in favor of variable annuities are that the average investor is not sophisticated enough to craft a better plan or stay the course and that all that variable annuity inflexibility is a feature which saves the investor from their own stupidity. Protecting investors against their own stupidity with a flawed product doesn’t seem like the right solution.
Jim W, CFP
Clark Howard earns a “commission” on everything he says and does. It’s usually a percentage of aum or website hits or whatever. He just chooses to call it something else to justify and cover up his greed and help him feel righteous.
As far as his his statement “all VA’s are garbage” what about fee-only VA’s w no surrender charges, tax deferral for NQ funds and probate advantages and diversification up the wing wang, etc. (I’m thinking of Jeff Nat product)
Maybe Clark can guarantee an income forever or a death benefit for the widow/children when the grim reaper strikes early and unexpected but I doubt it-unless he charges a hold your nose “commission”.
I, for one, am sick and tired of the Clak Howard’s and Suze Orman’s and other like idiots thinking they have a corner on good advice and pretending to be the gold standard for financial planning. I truly doubt either one could study sit for the CFP exam today and pass.
David John Marotta
Your characterization of how Clark Howard earns his money seems unfair. Trying to paint him as greedy seems like trying to sling enough mud so that commission-base agents don’t seem as dirty. If he is greedy then all financial advisors are greedy and it is important to choose an advisor compensated in a manner which overly tempts them to put their own interests before the clients.
I am certain that the majority of commission based agents and brokers are honest people who are trying to do honest work for their clients. But I also believe that human nature is bent, and that good intentions often succumb to repeated temptation.
Part of the annual fiduciary oath NAPFA members sign reads, “The advisor does not receive a fee or other compensation from another party based on the referral of a client or the client’s business.” Being fee-only helps reduce conflicts of interest based on how an advisor gets paid and what an advisor recommends.
I am certain that lumping charges by AUM or “website hits” into the same category as commission based products is an unfair characterization on your part.
Every commission-based agent takes exception to Clark Howard’s use of the term “all”. Finding a VA “w no surrender charges, tax deferral for NQ funds and probate advantages and diversification up the wing wang” doesn’t change the general tone that there are better ways to invest, including separating investment from insurance.
You may be sick and tired of the advice to consumers to prefer fee-only fiduciaries, but Clark Howard and Suze Orman are in good company. Calling them idiots and questioning their intelligence is just mean. Especially on this issue. I give individual commission-based agents the benefit of the doubt regarding their integrity and their intentions. I suspect that many believe they are doing what is best for the client. But I still think that the position they put themselves in does not engender trust that they know what is in the client’s best interests at heart. Especially not when they recommend variable annuities laden with fees and long lock-up periods.
Matthew Aston, CFP
Hi there DJM,
I always appreciate a person who picks an obviously controversial topic and uses it to strike up conversation. I do the same thing myself. Based on your background, you obviously have a sharp intellect, and no doubt enjoy this type of intellectual sparring.
While I am not going to take a position that commissioned advisers are inherently “dirty” or corrupt, I do certainly agree that often, they do allow the pay-cheque on the back end to determine the advice on the front end. I am sure that no member of this group, unless they just started in the business last week, would disagree with that. I would also agree that in and among them, there is a group of honest, hard working, ethical advisers that maintain a high level of professionalism and integrity in what they do. I would liken it to a mechanic… all I know how to do with a car is drive it… so I have to trust that my mechanic is honest and isn’t just “finding” work to fill in the slow times. That challenge has existed as long as man has been around and it is addressed in numerous historical philosophical writings. So let’s not just pick on the commissioned advisers out there, as we all struggle with remaining honest from time to time.
I spent many years working solely on a commission basis and have only recently switched to incorporate a fee for service model in my practice, so I am very familiar with both sides of that fence.
In regards to VA’s… The fees are in most cases high, and especially in the current economic climate where so many insurer’s have increased fees to offset their heightened capital requirements, and to offset losses incurred through GMWB products introduced over the last decade. I would generally disagree with the absolutism that permeates most sensationalist authors and that is true of this case too. There are a variety of VA’s that are available that are competitively priced and are not restrictive. They do not require a long term commitment and have a wide variety of underlying investment focuses to choose from. While I wouldn’t recommend them for a 30 or 40 year old who is still building his wealth, I would see a place for them for Estate planning applications. There are VERY few options available apart from VA’s that provide for smooth and easy estate settlement and estate bypass without opening up one’s situation to other more significant problems. Further, for us Ontario residents there are additional liability concerns coming for executors over the next year and VA’s provide an eloquent solution to mitigate that liability for the one’s that we care about who may be serving in that role.
I think that the point that a few of the contributors to this conversation were trying to make is this… while yes, they ARE often more expensive, that does not apply to every product offering out there (London Life Insurance Company in Canada for instance offers a high net worth VA offering that is all in cheaper than many of the options out there… and they are VA’s with all the benefits that go along with them). Nor is it wise to completely write them off, saying there isn’t a place for them in any circumstance. On the contrary, they may not apply to the majority of investment needs, but they do fill a very specific need for a specific group of people.
Thanks again for the opportunity to discuss a controversial topic. :o)
I guess hammers suck too, in the hands of someone trained only in screwdrivers. How do you value piece of mind and certainty? That’s the clients decision not the financial calculator’s. I am not sure there are any bad investment types, only bad applications.
David John Marotta
Greetings Joe Pires,
Perhaps I am just more jaded and cynical than you are. I’ve seen plenty of bad investments for which there is no reason for an investor to every purchase them. Our rules for safeguarding your money may hedge these dangers, but they give investors a better chance of meeting their financial goals. I’ve also heard the stories of bad advisors who do not seem to follow the procedures necessary to act in the best interests of a client, collecting barely enough information about a client or their goals for a suitability check.
I’ve not met the product that provides perfect piece of mind and certainty. Variable annuities certainly don’t. Such a claim violates our Safeguard #7: Avoid Investment Advisors Who Sugarcoat Reality. Tell me what product provides the certainty that my purchasing power will not be erased by an inflation black swan?
Hammers and screwdrivers are great. I’m more worried about avoiding the thumbscrews and land mines.